When it comes to taking out a mortgage, there’s one number that plays a pivotal role in determining the terms of your loan — your credit score. This three-digit number not only affects your ability to secure a mortgage, but it also impacts the interest rate you’ll pay, which in turn can influence your monthly payment and the overall cost of your home.
At Avanti Way Financial, we believe it’s important to understand how your credit score affects your mortgage rate, as well as what other factors lenders consider when approving your loan. Let’s dive into why your credit score matters, how mortgage lenders use it, and what you can do to improve your score.
Why Your Credit Score Matters
Your credit score is essentially a numerical reflection of your financial health. Lenders use it to assess how likely you are to repay your debts. It’s calculated based on several key factors, including:
- Payment history – Do you pay your bills on time?
- Credit usage – How much of your available credit are you using?
- Length of credit history – How long have you had credit accounts open?
- Credit inquiries – How often do you apply for new credit?
- Types of credit used – What kinds of credit accounts do you have?
Lenders typically use the median score from the three major credit bureaus — Experian™, Equifax®, and TransUnion® — to make decisions about your loan application. A higher credit score signals financial responsibility, suggesting you’re a low-risk borrower who’s more likely to make timely payments. On the other hand, a lower credit score might indicate a higher risk to lenders, leading them to charge higher interest rates to protect their investment.
How Mortgage Lenders Use Credit Scores
Mortgage lenders use your credit score as one of the key factors when determining the interest rate on your loan. A higher credit score typically means a lower interest rate, saving you money over the life of your mortgage. Conversely, a lower score can result in higher rates, leading to higher monthly payments and increased costs over time.
For example, let’s say two borrowers apply for the same loan. The borrower with the higher credit score is likely to be seen as a lower-risk borrower, meaning the lender is more confident that they’ll repay the loan. As a result, that borrower may receive a lower interest rate.
It’s important to note that your credit score is just one factor in determining your mortgage rate. Other elements, such as your income, down payment, and the overall state of the economy (including inflation and bond yields), also play a role in determining the rate you’ll receive.
When Credit Scores Matter Less
While credit scores are crucial for many types of mortgages, they are not always the deciding factor. Some lenders may focus more on other factors such as your income, savings, and history of paying rent or utilities on time. This can be especially relevant for borrowers who have limited credit history or prefer not to use credit cards.
Certain government-backed loans, such as FHA, VA, and USDA loans, may have more flexible credit score requirements. For example, FHA loans allow for lower credit scores, with a minimum score of 580 for a 3.5% down payment, and some USDA loans place more emphasis on income and expenses rather than the credit score.
What Credit Score Do You Need for a Mortgage?
Credit scores range from 300 to 850, and they’re typically categorized as follows:
- Exceptional: 800 – 850
- Very Good: 740 – 799
- Good: 670 – 739
- Fair: 580 – 669
- Poor: 300 – 579
For conventional loans, lenders generally prefer a score of at least 620. FHA loans have lower requirements, allowing for a score as low as 580 with a 3.5% down payment. Other loans, like USDA and jumbo loans, may have their own thresholds, with some requiring a score of 640 or higher.
How to Improve Your Credit Score
If your credit score is less than stellar, don’t worry — there are steps you can take to improve it before applying for a mortgage. Here are a few strategies:
- Review Your Credit Reports – Check for errors that could be negatively impacting your score. You’re entitled to one free credit report per year from each of the three major bureaus through AnnualCreditReport.com. Mistakes like inaccurate late payments or accounts that don’t belong to you can lower your score.
- Make Timely Payments – Pay your bills on time each month. Even one late payment can damage your credit score. If you’ve missed payments in the past, bringing your accounts current is crucial.
- Pay Down Credit Card Balances – Try to pay off credit card balances before the due date. Keeping your credit utilization low can have a positive impact on your score.
- Don’t Close Unused Accounts – Closing old credit cards can hurt your credit score by reducing your available credit and increasing your credit utilization rate.
- Limit New Credit Inquiries – Applying for new credit frequently can lower your score. Only apply for credit when necessary.
Credit Score FAQs
Here are answers to some common questions about credit scores and mortgages:
- Can I get a mortgage with a low credit score? Yes, it’s possible, but expect higher interest rates and potentially a larger down payment. Certain loan types, like FHA or VA loans, may have more lenient requirements.
- Will I get a better interest rate with a higher credit score? Absolutely. Lenders typically offer lower rates to borrowers with higher credit scores because they’re seen as less risky.
- Which credit score is most important when buying a house? Mortgage lenders generally use the FICO® Score, which considers the scores from Experian™, Equifax®, and TransUnion®.
- What is the minimum credit score to buy a house? It depends on the loan type. For conventional loans, a score of at least 620 is typically required. FHA loans may accept scores as low as 580, while USDA loans may require a minimum of 640.
The Bottom Line
Your credit score plays a critical role in securing a mortgage, but it’s not the only factor lenders consider. By maintaining good credit habits and improving your score, you can position yourself for more favorable mortgage terms, saving you money in the long run. Even if your credit score isn’t perfect, don’t let that stop you from pursuing homeownership. With the right steps, you can improve your credit and secure a loan that works for you.
If you’re ready to take the next step toward homeownership, Avanti Way Financial is here to guide you through the mortgage process. Contact us today to start your journey and explore your options.
