How Credit Impacts Your Ability to Get a Home Loan

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There are many factors that lenders use to assess your application for a mortgage. Understanding these criteria can help you prepare for your application and get you better results. Your credit score is one significant aspect lenders assess when you apply for a home loan.

Whether you’re a seasoned property investor or a first-time homebuyer, understanding the connection between credit scores and home loans can make your application stronger and even save you money.

What is a Credit Score?

A credit score is a number that represents a potential borrower’s creditworthiness. It typically ranges from a low of 300 to a high of 850. Higher scores indicate a more favorable credit history, suggesting lower risk to lenders.

Your credit score is based on various components, including your on-time payment history, total amounts owed, length of credit history, types of credit, and recent credit inquiries.

Why a Credit Score Matters to Lenders

Credit scores provide a snapshot of your financial reliability. They showcase how well (or not) you’ve managed past credit responsibilities. Lenders use credit scores to evaluate the risk associated with lending money or extending credit to an individual. 

A strong credit score indicates a history of responsible financial behavior, assuring lenders that the borrower is more likely to repay the loan on time and potentially leading to more favorable loan terms. 

A lower score may suggest potential payment issues. Often, low credit scores can make lenders hesitant to approve the loan. If the lender does approve the loan, it may offer less favorable loan terms to offset the additional risk of a less financially secure applicant. 

What Credit Score Do You Need for a Good Mortgage Rate?

Generally, the higher your credit score, the better the mortgage rate and loan terms you can secure. While the specifics may vary between lenders, here’s a general breakdown:

  • Excellent (800 or higher): Individuals in this range can typically expect the best available mortgage rates.
  • Very Good (740-799): Still excellent, likely to secure favorable rates.
  • Good (670-739): While not the best rates, rates are still competitive.
  • Fair (580-669): Rates might be higher, and terms less favorable.
  • Poor (579 or lower): Qualifying may be challenging, and rates will be significantly higher.

Different types of mortgages might have varying credit score requirements. For example, while many conventional loans require a score of at least 620, Federal Housing Administration (FHA) loans might approve borrowers with scores as low as 500 with certain conditions. 

On the other hand, jumbo loans, which are larger loans for amounts higher than most mortgage providers offer will often require higher scores, ideally between 680 and 700.

Options if You Have a Low Credit Score

A less-than-stellar credit score isn’t necessarily the end of your homeownership dreams. If you’re facing credit challenges, you may consider these alternatives.

Consider an FHA Loan

Government-backed FHA loans may offer a silver lining to those with lower credit scores. While traditional lenders might shy away from credit-challenged borrowers, the FHA provides an endorsement, making it easier to secure a mortgage. 

Save for a Larger Down Payment

Sometimes, a substantial down payment can be your strongest negotiation tool. By investing a significant amount upfront, you demonstrate commitment and reduce the lender’s risk. This approach might not only secure loan approval but could also lead to more favorable terms, potentially counteracting the impact of a low credit score.

How to Improve Your Credit Score

Improving your credit score takes time, but following a few strategic steps can help you make a measurable impact. By understanding the key factors that influence your score, you can adopt habits that will give it a boost, eventually leading to more favorable mortgage loan terms.

Regularly Review Your Credit Report

It’s more common than you might think for mistakes to occur on your credit report. By reviewing your report and addressing discrepancies right away, you can make sure your credit score reflects your actual financial behavior. Commit to regularly pulling and carefully reviewing your credit reports from the three major credit agencies – Experian, Equifax, and TransUnion.

Strategically Manage Your Credit Card Balances

Your credit utilization rate is a key factor that impacts your credit score. This is the amount of credit you’re using compared to your credit limit. Generally, lenders prefer borrowers who keep their ratio below 30%. For example, if your credit limit is $10,000, try to keep your balance below $3,000.

Ensure Consistent, Timely Bill Payments

Your payment history is a significant component of your credit score. By ensuring all bills are paid on time, you can build a reputation of financial reliability. Consider setting up automatic payments to avoid inadvertently making late payments.

Maintain Older Credit Lines

While it might seem wise to close out old or unused credit cards, doing so can increase your credit utilization ratio. Instead, keep them open and use them occasionally to keep the account active.

Limit New Credit Inquiries

When you apply for credit, the lender makes a hard inquiry, which can cause your score to temporarily dip. To avoid a negative impact when shopping for mortgage rates, plan to do all of your inquiries within a short period of time, ideally 14 days. Multiple inquiries within this time period will count as one hard inquiry for credit-scoring purposes.

Also, avoid taking out additional credit while you’re in the process of applying for a mortgage. This includes actions such as opening new credit cards, financing a furniture purchase, or buying a vehicle.

Explore Your Mortgage Options with Keller Home Loans

When you’re on the path to homeownership, the right guidance can make all the difference. At Keller Home Loans, we’re committed to providing tailored solutions that fit your unique needs. Whether you have an excellent credit score or are seeking ways to overcome financial challenges, our team is here to assist. Contact us today to explore your mortgage options.

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