Knowing your credit scores is a good idea for many reasons. Everything from qualifying for a credit card or an auto loan to getting utility services or renting an apartment can be impacted by how good your credit score is. Buying a house is no different and knowing the credit score needed to buy a house is an important first step in your home ownership.
Your credit score helps determine the interest rate and other costs you pay on a mortgage loan. If your credit scores are high, it tells lenders that you’ve paid your credit card bills on time, haven’t “maxed out” your credit cards, and so on. Lenders see you as likely to pay your loan payments consistently and on time. They see you as a low-risk investment and offer you a lower interest rate and other costs on your loan.
If your score is lower, lenders see you as a risky investment. And, if they approve you for a loan at all, will charge you a higher interest rate in exchange for taking on your perceived risk.
How Lenders View Your Credit Score?
Your credit score is a number that represents where your credit profile stands. Different credit models give slightly different scores, but each is based on certain factors that look at how you do and have used credit—credit cards, loans, etc.
Imagine your friend asks to borrow money. Assuming you had the money to loan, you might ask yourself, “Did he pay me back the last time he borrowed money? Did he pay me back the full amount? On time?”
If the answer to those questions is “yes,” chances are, you loan your friend the money.
If the answer to any of those questions is “no,” you may not want to loan your friend money or you may only do so with certain conditions in place.
To lenders, like mortgage lenders, a good or excellent credit score equal “yes” answers to these type of questions on your ability and likelihood of paying your home loan on time and consistently. A low credit score and poor credit reports equal “no” answers to just those types of questions and the lender may not want to loan you money or only be willing to do so with certain conditions and safeguards in place.
What Credit Score Do I Need to Buy a House?
Most lenders have a baseline credit score they use to approve or deny mortgage applicants. Any score in the 700s or above is considered excellent and will most likely get you a loan with the lowest interest rate.
When your score drops into the 600s you start to be seen as a potential risk for loaning money to. A score of 680, for example, is still considered good, but when you get below 660, some lenders start saying no. For others, 640 or 620 is the line at which consideration for a better mortgage loan program may be off the table. It all depends on that particular lender and their required qualifications.
Those scores and cut-off points are for conventional fixed-rate mortgages. Other types of mortgages, such as FHA or VA, are easier to get and even designed for borrowers with credit scores as low as 500.
Can I Buy a House with Bad Credit?
Once your credit score drops into the 500s, you’re a candidate for a bad credit home loan or what the industry calls a subprime loan. Subprime loans have interest rates that are a couple of percentage points higher than those offered to prime borrowers. Subprime loans also often come with additional fees.
For example with a lower credit score, you’ll likely pay a 0.375% higher interest rate than the average 30-year fixed-rate mortgage compared to someone with a credit score above 700. If the 30-year primary mortgage rate is 3.875%, someone with good credit would pay 4.125% in interest (.25% above the primary rate) and you’ll pay 4.5%.
Your monthly payment will be $82.99 more each month and $29,876.40 more over the 30-year life of the loan. And if you can’t make a 20% down payment, a lender will want you to pay a private mortgage insurance (PMI) premium that might be 110% of the loan amount annually and comparably higher than the premium for someone with good credit.
So, the answer to the question is that you might be able to buy a house using a conventional fixed-rate mortgage if you have bad credit, but only at a higher interest rate and with added fees. The end result is that a bad credit score will cost you more money each month and over the life of the loan.
How to Improve Bad Credit
Your credit score isn’t set for life. If you have a bad credit score, there are ways to improve your creditworthiness and increase your score. Take a look at your financial habits and see where you can improve—can you be better about paying your bills on time or limiting the number of hard inquiries you’re making against your credit? Perhaps you could pay down some of your other debt or review your credit reports for any errors and dispute them if there are any.
If you want help with specific steps, get your free score on Credit.com. When you do, you get a free credit report card that includes ways to improve your credit in each of the main areas that go into your credit score.
From a financial standpoint, it’s better to take the time to improve your credit and make yourself eligible for a better interest rate than it is to apply for a loan with a credit score that will only make you eligible for a subprime rate. That said, you may not be able or want to wait. In that case, know that you can potentially refinance for a better rate later on.
Is an FHA Loan an Option for Me?
If you know your credit scores will hurt your ability to get a conventional mortgage or affect your rate, a Federal Housing Administration (FHA) home loan may an option for you. FHA loans have easier underwriting standards for buyers who have small down payments, low credit scores or both.
The minimum FICO credit score for an FHA loan is 500 or higher. If your score is at least 580, you also need at least a 3.5% down payment. You can still get approved for an FHA loan with a credit score lower than 580 and down to 500, but you’ll need a larger down payment of at least 10%.
A Few More House Buying Tips
If you are in the process of choosing a lender and getting prequalified for a mortgage loan, there are several things you can do to begin the process on the right foot.
Gather Your Financial Documents
First, your mortgage lender is going to want to see certain financial records and documents. This is especially true of borrowers with bad credit. To fulfill this requirement, you want to get as organized as possible before applying for a mortgage loan
Tax returns, pay stubs, bank statements, W2s and a list of all your debts are just a few documents you should gather and have ready to go.
Consider Using a Co-signer for the Loan
If your credit is bad and you still want to have access to decent mortgage rates, you can consider a co-signer. Co-signers can help borrowers with poor credit or inadequate credit history increase the chances of loan approval.
Find Out Where Your Credit Stands
Higher interest rates will make affordability a factor in 2019. Just a half-percent difference can make or break some budgets, depending on the amount of the loan you take out. So, it’s worth considering whether you can afford a big-ticket item such as a house. You want to know what your credit score is and keep it or increase it to as high as possible in order to score a great rate and keep your housing payments manageable.
To improve your credit, pay down your credit card balances, maintain a low credit utilization ratio—under 30%—and avoid making late payments.
This article was last published March 13, 2017, and has since been updated by another author.