With interest rates going up throughout 2022, many people are trying to jump on home-buying as soon as possible. As of today’s article, the prime interest rate is a whopping 5.5%, meaning the price of a home has gone up significantly in the past year.
I’ll break down some common loan types, and what creditors are looking for. In the next section I’ll tell you why your credit score matters so much for home loans. After reading this, if you're interested in raising your credit, check out my reviews of credit repair businesses.
What Creditors Look For
According to data from Rocket Mortgage and Quicken Loans, you can expect a rejection if your credit score is lower than 620. Ideally, your best odds of getting a loan are if your score is 700 or higher. Keep in mind, the higher our credit score, the better our loan will be. Here is a breakdown of four types of loans, and what it takes to get them.
For qualified first-time homebuyers, you can apply for a loan backed by the Federal Housing Administration. The minimum credit score for this loan is 500. I need to warn you, though, that being “backed” by the FHA doesn’t mean that’s to whom you’re applying–and it’s not who will approve the loan.
“Backing” a loan simply means that it is insured or offered through that program, in partnership with conventional mortgage lenders, like banks and credit unions. That means that even if you meet the minimum 500, you could still be rejected by the bank, or face higher interest rates or a larger down payment.
Minimum Score by Law: 500
Best Chance Score: 580+
Legally, this loan has no minimum score. It is backed by a government program though, in this case, the office of Veterans Affairs. But I can’t find any offers for credit scores below 580.
The good news is, if you qualify for a VA loan, there’s now down payment.
Minimum Score by Law: N/A
Best Chance Score: Low 600s
The United States Department of Agriculture has an interest in seeing people move to more rural areas, and to entice people, they’ve begun offering USDA loans. In addition to meeting lower income standards (you can’t make much more than the average income), you also need a credit score of 640 for most lenders. Like the VA loan, USDA loans have no down payment.
Minimum Score by Law: N/A
Best Chance Score: 640
Here’s where most homebuyers fall. We’re not first-time buyers, or we’re not Veterans, or planning to own a home in the country. While there is no law governing minimum scores for loans in this category, I found multiple lenders who set their minimum at 620.
Best Chance Score: 620
Take all these minimums with a grain of salt. The fact is that the average Credit Score of people buying a home in 2021 was 760. Looked at another way, banks will only issue so many home loans a year, and they’re looking for qualified borrowers. If your credit is lower than 760, you’re not competitive with other prospects, from the bank’s point of view.
Why Credit Scores Matter
There are two major things that a lender might do to your home loan offer if your score isn’t great–even if it meets their “minimum” threshold. The first is to increase your down payment; the second is to increase your interest rate.
Increase Down Payments
Banks and lenders are always looking to get people in the door. One way they do that is by advertising loans to people with low credit scores. What they don’t tell you is that the lower your credit score, the higher a down payment they’ll require of you. While there are lending programs that offer as low as 3%, or even 0% down payment options, these typically require better credit scores.
Even in the FHA program, where you only need a 500 credit score, they still impose a penalty of jacking up your down payment from 3.5% to 10%. For a $250,000 home, that’s a down payment increase of almost $20,000.
Increased Interest Rates
Another thing banks don’t tell you, if your credit score isn’t high enough, they could increase your interest rate. While there are laws protecting you from your rate going up while you’re under contract, there’s nothing stopping banks from increasing the interest before you sign the dotted line.
In some cases, even with FHA or similar programs, a bank could do both–raise your down payment, and raise your interest rate. That’s why it’s so important to keep your credit score up.
In the end, banks are in the business of making money, and we should never forget that. Even when it’s our dreams on the line, on our end, it’s their business. Banks don’t want to offer low payments or low down payment requirements to people who don’t look like responsible borrowers.
And whether we like it or not, our credit score is how they determine if we’re good borrowers. So keep your credit score up, monitor it, and boost or repair it as often as you need to.
Here are some general tidbits I’ll offer on the way out. I include them to give you an idea of what the home-buying market has looked like for the past 18 months or so.