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 ride on how good your credit scores are. Buying a house is no different, and knowing the credit scores you need to do so is an important first step in your home search.
That’s because your credit scores help determine the rate and conditions you receive on a mortgage loan. If your credit scores are high, meaning that your credit history indicates you’ve paid your credit card bills on time, haven’t “maxed out” your credit cards, etc., then lenders believe it’s a fairly good bet you won’t have difficulty paying off your loan. They will see you as a low-risk investment and offer you a low rate on your loan with good conditions.
If your scores are lower, lenders are more likely to think you’re a riskier investment, and charge you (by loaning you money at a higher interest rate) to take on the perceived risk.
What Is a Credit Score?
Your credit score is a number that represents where your credit profile stands based on five determining financial factors. Imagine that a friend asks to borrow money from you. Assuming you had the money to loan, you might then ask yourself, “Did he pay me back the last time he borrowed money? Did he pay me back the full amount? On time?” When you approach banks and lenders for a loan, they go through a similar analysis, but because they don’t know you personally, they use your credit history to determine whether you will be a responsible borrower. Lenders learn about your credit history by looking at your credit report.
Credit reports are developed by three separate credit agencies. These agencies (Equifax, Experian and TransUnion) gather information about your credit history and use a formula to assign you a credit score. You will end up with three slightly different credit scores from each of these bureaus, as they don’t all show the same information.
What Credit Score Do I Need to Buy a House?
Most lenders have a baseline credit score by which they largely make their decision to approve or deny mortgage applicants. On most scoring scales, the maximum credit score is 850, though a score of a perfect 850 is rare. Any score in the 700s or above is typically considered excellent and will most likely get you a loan with the lowest interest rate. When your score drops into the 600s, it starts getting dicey. 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 you won’t be considered for their better programs. It all just depends on that particular lender.
Can I Buy a House With ‘Bad’ Credit?
Once your credit score drops into the 500s, you are a candidate for a bad credit home loan or what the industry calls subprime loans. These 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.
So, if you’ve ever missed a credit card payment deadline, for example, you might’ve thought it was no big deal. You pay the late fee and move on. But if you do this on a regular basis, it can damage your score and cost you many, many times that amount when you want to buy or refinance a home. That’s the bad news.
How to Improve ‘Bad’ Credit
Your credit scores aren’t fixed in stone. If you have bad credit scores, there are ways to improve your credit health. Take a look at your financial habits and see where you can improve — can you be better about paying on time or limiting the number of inquiries you’re making against your credit? Perhaps you could pay down some of your other debts or review your credit reports for any errors (and dispute them if there are).
From a financial standpoint, it is almost always better to take the time to improve your credit health, 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 loan.
Is an FHA Loan an Option for Me?
If you know your credit scores could hurt your ability to get a conventional mortgage, a Federal Housing Administration (FHA) home loan could be an option for you. That’s because FHA loans can provide easier underwriting standards for buyers who have small down payments, low credit scores, or both.
Things to Keep in Mind This Year
Buying a home is still a goal for many, but higher interest rates will make affordability an even bigger factor in 2017. 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’ll also want to keep your credit score as high as possible in order to score a great rate and keep your housing payments manageable, as Scott Sheldon writes on our blog.
Find Out Where Your Credit Stands
Before you begin exploring mortgage financing options, you can check your credit scores by getting two free credit scores on Credit.com. With these two completely free scores, you’ll also have access to a tool that shows you how your payment history, debt and other factors are affecting your scores, and you’ll get recommendations for steps you may want to consider to address problems. It’s important to remember that checking your own credit reports and scores does not affect your credit in any way.
This article has been updated. It was originally published on December 12, 2016.