Buying a home is one of the most exciting things you can do in your life — not only does it provide a place to live but it gives you a sense of ownership and control that is almost unparalleled.
However, there are also some difficult steps along the way to successfully purchasing your new home. One of those steps is knowing if you can qualify for a mortgage. Your credit score is, of course, a big part of this process.
In this blog post we explain how to evaluate your credit score and how to improve it in order to buy a home.
What is my credit score?
If you don’t know your credit score, you can a free online tool to check it:
It’s important to note that there are three credit bureaus (TransUnion, Experian, and Equifax) and each one may have a different score for you. In most cases, though, your scores should be similar for all three bureaus.
Can I buy a home with my credit score?
Once you know your credit score, you need to evaluate whether your score is high enough to purchase a home. Let’s take a look at what kind of credit score is necessary for each type of mortgage loan:
FHA Loan: The Federal Housing Administration insures certain loans to help home buyers purchase a home, typically with a lower down payment. The minimum credit score for an FHA loan is 580.
Conventional Loan: A conventional loan is the most common type of mortgage. It is backed by one of the Government Sponsored Enterprises, Fannie Mae or Freddie Mac. The minimum credit score for a conventional loan is 620.
Jumbo Loan: A jumbo loan is for any home that is priced above the conventional loan limits, meaning it will not be backed by Fannie Mae or Freddie Mac. The minimum credit score for a jumbo loan is 720.
While these are the minimum credit scores, it does help to have a higher credit score because it will usually allow you to get a lower interest rate and save money on your mortgage payments.
How can I improve my credit score to buy a home?
Whether you need to raise your credit score in order to qualify for a mortgage or simply to lower your interest rate, there are some concrete steps you can take to improve your credit score. Here are the factors that determine what your score is, along with how heavily they are weighted in your score:
Payment History (35% of Score):
It’s no surprise that making your payments on time is the best way to improve your credit score, and if you make a late payment it will hurt your credit score. But there is a difference depending on how late your payment is. If your payment is just a few days late, your lender will often give you a grace period and will not report a late payment to the credit bureaus. On the other hand, if you’re over 90 days late, it will almost certainly be reported to the credit bureaus and will have a negative impact on your score.
In addition to paying on time, you can also improve your credit score by paying any past due amounts. For example, if you have a medical bill or credit card bill that is two months late, you can improve your score by making that payment and getting your account back in good standing. You should also pay close attention to any phone calls or letters you receive from a collections agency — just in case you’ve accidentally missed a payment or in case someone else’s debt has been placed on your credit report by mistake.
Amounts Owed (30% of Score):
One of the most influential factors in your credit score is something called your credit utilization ratio. This is a fancy term that simply answers the question “How much of your available credit are you using?”
For example, if you have one credit card with a credit limit of $10,000 and you have a balance of $1,000, then you are using 10% of your available credit. On the other hand, if you have two credit cards, each with a $5,000 credit limit, and each one is completely maxed out, then you are using 100% of your available credit. To improve your score, try to reduce the amount of credit you are using (but don’t cancel any cards because that will lower your available credit). Ideally, you should use between 0% to 30% of your available credit.
If you have an auto loan, your credit score will get better as you pay off the loan. An entirely paid off — or almost paid off auto loan — will help your credit score more than a brand new auto loan with only a few payments made.
Length of Credit History (15% of Score):
The credit bureaus look more favorably on borrowers with a longer credit history because it shows a pattern of behavior. In order to improve your length of credit history, you should start building your credit as early as possible. Get a credit card if you don’t already have one — you can always hide it somewhere safe if you don’t plan on using it.
If you already have a credit card (or several), don’t close those accounts. Just cut up the card if you don’t want to use it anymore. Your oldest credit card can be your most valuable asset when it comes to your credit score, because it indicates that you have a long credit history. It’s a good idea to review all your accounts by checking your credit report once a year for free at AnnualCreditReport.com.
Credit Mix (10% of Score):
Surprisingly, the credit bureaus prefer to see borrowers who have a mix of credit accounts. For example, having a credit card, an auto loan, a store card, and a mortgage loan will help your credit score more than just having a credit card.
However, you don’t want to open new accounts or loans just to help your credit score. The credit mix is only a small part of what makes up your credit score, and it would be much worse to take on new accounts you can’t handle than to have fewer accounts.
New Credit (10% of Score):
You should know that opening new credit accounts, or even applying for them, can have a temporary negative effect on your credit score. That is because credit bureaus view opening several credit accounts in a short period of time as representing a greater credit risk.
There is one exception to this rule: if you are rate shopping for a student loan, home loan, or auto loan, and if you conduct your rate shopping within a period of 30 days, you will generally not be penalized for applying for more than one loan at the same time.