Step 3: Understanding Your Credit

Lenders look at two key factors when deciding whether to approve or deny loan applications: credit history and credit score. If you haven’t looked at your credit report or score in a while, do this as soon as possible so you can address any issues before trying to get a loan. In this guide, we’ll answer some of the questions home buyers have about credit.

Can I Buy a Home with Bad Credit or No Credit?

Yes, you can still buy a home with bad credit or no credit. Having imperfect credit doesn’t mean you can’t get approved for a mortgage. A borrower with imperfect credit may still be offered a loan, but in many cases, it will have a higher interest rate. Your lender may also require more money down or advise you to purchase a less expensive home.

However, the higher your credit score, the better. A high score helps ensure that you’ll get the lowest interest rate on your home loan. A borrower with fair or worse credit may find it more challenging to get approved, and they will have fewer options.

Here’s how your credit score can affect your interest rates and approval odds:

  • Exceptional Credit (760+): Having a top-tier credit score will enable you to take advantage of the best rate available at the time.
  • Excellent Credit (720-759): If you’re in this range, it may slightly impact your interest rate, but only a little (usually no more than 0.25 percent higher than the lowest rate).
  • Good credit (680-719): If your credit is good, but not great, this will impact your interest rate a bit more. Typically, if you have good credit, you’ll be offered loans with interest rates about 0.5 percent higher than the lowest rate.
  • Fair credit (620-679): This is where the divide widens in relation to the interest rate. Borrowers with fair credit can expect to pay about 1.5 percent higher interest than the lowest rate available.
  • Poor credit (580-619): While it isn’t impossible to get approved for a mortgage with poor credit, it will be more difficult. Borrowers with poor credit can expect to pay rates anywhere from two to four percent higher than the lowest rate.
  • Bad credit (350-579): It will be difficult, but some borrowers might still be able to get approved with very poor credit. However, they’ll likely pay an extremely high interest rate.

Ideally, you want your credit score to be 700 or above when applying for a mortgage. While it’s still possible to get approved with a score below 700, the interest rate will start impacting the overall cost of the home.

If you don’t have any credit, the lender will likely require you to provide another means of creditworthiness. In most cases, the lender will want to see your history of paying your utility bills, cable bills, phone bills, or any other monthly expenses. While it is possible to get approved for a mortgage with no credit, it will be more challenging than if you had an established credit history.

What Credit Score Do I Need to Buy a Home?

Different types of home loans have different credit requirements. For example, a conventional loan has a minimum FICO score of 620 for approval, but an FHA loan is a little more lenient. To get an FHA loan, a borrower needs to have a credit score of at least 580 to get approved. VA and USDA loans don’t have set minimums, but mortgages are rarely approved for those with credit scores lower than 580. Generally, you want a credit score of 600 or above to buy a house.

If you have poor credit, buying a home will be more challenging, but it isn’t impossible. Get copies of your credit reports and review them for inaccuracies. Simply disputing an incorrect piece of information can help raise your score once the information is removed.

Once you’ve reviewed your credit and resolved any incorrect information on your credit report, it’s time to get prequalified by a lender. This will tell you how much home you can afford, and it will show sellers that you’re a serious buyer.

Remember: a prequalification letter isn’t a guarantee for a loan. Your credit score and history need to stay the same or improve between the prequalification and the loan approval. Don’t apply for any credit cards or loans, and don’t allow any of your accounts to go delinquent during this period. If your credit takes a hit, your prequalification won’t mean anything.

What Are Lenders Looking for in a Credit Profile?

When a lender reviews your credit, they’re looking for certain factors. Some of these factors are more important than others. Knowing what lenders are looking for will help you concentrate on the most important parts of your credit profile. Here’s a breakdown of what lenders look at most when deciding on a loan approval:

  • Payment history (35%)
  • Credit utilization (30%)
  • Age of credit (15%)
  • Different type of credit (10%)
  • Number of credit inquiries (10 %)

Because payment history is so important to lenders, you’ll want to make sure you don’t miss any payments on your debt obligations. One way you can do this is by setting payment reminders for yourself through your bank. You can also arrange for your bills to be paid automatically from your bank account. If you choose this direction, schedule your payments a few days before the due date to ensure the payment is made on time.

A great way to improve your credit is to reduce the amount of debt you owe. To do this, stop using your credit cards. Review the interest rates for all your credit cards and create a budget that allows you to pay more on the card with the highest rate. Once that card is paid off, start applying the extra money to the next card with the highest rate. By tackling debt this way, you’ll save money and improve your credit steadily over time.

Another approach is to knock out the credit card with the lowest balance first, then move to the next, applying the extra money to that card. Either approach will reduce the amount of debt you owe, so choose a method that makes the most sense for your situation.

If you missed payments in the past, concentrate on getting all your accounts current and keep them current. The impact of missed payments lessens over time. Here are some more tips to improve your credit:

  • Keep the balances on revolving credit accounts as low as possible
  • Pay off debt instead of moving it from card to card
  • Don’t apply for new cards if you don’t need them
  • Don’t close paid or unused credit card accounts. The older the accounts are, the higher they’ll make your credit score.

While it only takes a few mistakes to damage your credit, improving your credit will take time. If your credit needs work, it might be best to hold off on trying to get a mortgage and focus your energy on getting your credit where it needs to be.