We often hear about the importance of a credit score in making big purchases such as a home or vehicle, but rarely is that notion explained. Yes, it plays a part, but how does a credit score affect buying a house? Your credit score can mean the difference between the home of your dreams and no home at all, as it is a reflection of your financial stability and trustworthiness. To help you further understand home buying, there are several ways your credit score may play into your ability to purchase a new house.
How Lenders Use Your Credit Score
One of the most important things you must understand about the home-buying process (or securing any big loan, really) is that there is no single credit score that determines your eligibility for such a purchase. There are many different types of credit scores determined by multiple agencies, and the lender you’re applying to likely uses the one you’ve been monitoring. This is especially the case for those scores determined by one-time online free credit reports.
Although these tools are useful in your ability to monitor the health of your credit, what your lender sees depends primarily on what type of score they request. Any score will be determined by the following elements (each of varying importance):
- Payment History
- Amount of Debt (installment and/or revolving credit) Owed
- Years of Credit History
- New Lines of Credit
- Types of Credit in Your Name
Credit scores in the neighborhood of 650 are typically regarded as a passing score, eligible to receive the average mortgage loan. Some lenders are willing to go as low as 620, but will normally require either a larger down payment or higher interest rate as a form of security.
This is because a score in the low 600s is indicative of several possibilities including:
- Multiple late payments
- High debt-to-income ratio
- High credit utilization
In the eyes of lenders, these things can be a sign that an individual is not the most financially responsible, and may not be in a position to successfully repay their loan. (Note: For those house-hunters with credit scores between 580 and the standard minimum of 620, consider a Federal Housing Administration, or FHA, loan.)
Scores of 740 and higher are seen as excellent, and home-buyers with such scores will typically receive the best mortgage rates available.
Strengthen Your Credit Before Buying a Home
Because of how important your credit score is in the purchase of a new home, you need to make sure that it is in prime condition before you begin seriously shopping for new homes. The most important steps to take in repairing or maintaining your credit are:
- Avoid opening and/or closing accounts: Lenders like to see diversity in credit utilization. Although it may feel “wrong,” in a sense, having multiple accounts – such as credit cards, car loan, etc. – will strengthen your credit report, as long as all accounts are current.
- Avoid excessive credit utilization: It is best to avoid exceeding 30% usage of your credit lines.
- Review your credit report: Know ahead of time what information is present on your report. That way, if there are any inaccuracies, you can have them removed.
Your credit score is more than just a number – it is a reflection of your financial habits and a reliable indicator to lenders of what type of customer you’ll be. With a high credit score, you’ll be able to qualify for the best mortgage loans with low-interest rates, boosting your chances of qualifying to purchase your favorite home!