Three digits. They may be all that is standing between you and your own home or continuing to rent. Known as your “credit score,” those digits reflect how risky it will be to lend you money. The score may also impact other aspects of the homebuying process as well.
How your credit score is calculated
The road to your credit score, also known as a FICO® Score, begins with the credit reporting agencies. Known as “the big three,” they include Equifax, TransUnion® and Experian®.
The information the agencies collect ends up in the hands of the Fair Isaac Corporation (or, the aforementioned FICO®, for short), one of the nation’s top two credit scoring companies.
Ninety percent of what FICO calls “top lenders” rely on your FICO score to determine your credit risk and how much they will charge you for the money you borrow.
FICO’s score calculation is complicated and secret. What they end up producing, however, is a three-digit score from each of the reporting agencies.
“Mortgage lenders usually take the middle score” from this subset, according to Craig Anthony at investopedia.com.
“For example,” he continues, “if your credit scores from the above agencies are 710, 690 and 610, the lender typically makes its decision based on the 690 score.”
Learn more about how FICO determines your score at myfico.com.
What is considered “good” credit for a mortgage?
FICO Scores can range from a low of 300 to a high of 850. According to FICO, about 1.4 percent of Americans with credit scores have a perfect 850.
Last summer, however, the company announced that the average score in the United States reached an all-time high of 704, up four points from 2017’s average.
So, what’s the magic number you’ll need to buy a house?
It depends on the type of loan you’ll be pursuing.
- FHA – 580 and above to qualify for the 3.5 percent down payment and 500 and above with a 10 percent down payment.
- Veterans Administration (VA) – The VA doesn’t loan money so it doesn’t mandate a minimum credit score. Most VA lenders want to see at least a 620 score, although some lenders may approve a borrower with a 580 score.
- Rural Development (USDA) – 640 and above.
- Conventional loans – 620 and above
Since requirements change occasionally, use the above minimum scores as a general guideline and consult with a lender for current requirements.
How does a low score impact the homebuying process?
If you find your credit score on the borderline, just barely acceptable to a lender, you may run into the following problems along the road to homeownership.
You’ll pay more for your house payment every month
First, your credit score will determine the interest rate on your loan.
Use FICO’s Loan Savings Calculator to determine how much money you can save by raising your credit score before applying for a loan.
Home insurance rates are higher for those with poor credit
If you won’t be paying cash for the home, the lender will demand that the home be insured. And, if you’re credit is poor, you’ll pay more than homeowners with good credit pay.
“People with poor credit pay at least twice as much as people with excellent credit in 37 states and Washington, D.C.,” according to Laura Adams, InsuranceQuotes’ senior analyst.
Live in West Virginia? A poor credit score may doom you to paying more than twice the rate (208 percent).
And, since insurance is one of the four components of your mortgage payment (principal, interest, taxes and insurance), a higher premium will impact how much you pay for the home each month.
How quickly can I raise my credit score?
The first step to take when trying to raise your credit score quickly is to look for errors in your credit reports. You are entitled to a free copy of your reports every 12 months, from all three credit reporting bureaus.
The Federal Trade Commission recommends that you order these reports from annualcreditreport.com, the only agency authorized by the U.S. government.
Items to look for in your credit report include:
- Personal information – Ensure that your name, address and Social Security number are accurate.
- Check all listed account numbers for accuracy.
- Check that there are no accounts listed as closed which are actually open.
- Look for accounts that are incorrectly listed as delinquent.
You will find more tips on what to look for in your credit report online, at consumerfinance.gov. If you find errors, dispute them according to the bureau’s instructions. These are listed on each credit report.
In the meantime, don’t open any new credit accounts. Since the credit bureaus don’t know how you’ll use this credit, they consider you a higher credit risk with new credit and it may result in as much as a 10-point reduction in your score.
Don’t close any credit card accounts, either. The lack of installment credit makes you appear riskier.
Pay your bills on time
Since your payment history accounts for 35 percent of your credit score, late payments are brutal on your credit score. Start meeting those payment deadlines.
Consider putting the accounts that you typically pay late on an automatic payment schedule with your bank.
Don’t be shy about obtaining financial counselling. You’ll find a list of approved credit counseling agencies on the Department of Justice website.
Or, consider meeting with a non-profit housing counselor in your area. You’ll find a list of U.S. Department of Housing and Urban Development-approved counselors online at consumerfinance.gov.