Why Does Your Credit Score Matter When Applying for a Mortgage?

In the financial world, credit scores are a tool. But whether they work as a lever or a hammer depends on how good they are in a specific setting.

Let’s answer your most asked questions about credit scores and why they are so important.

Why Is Your Credit Score Important to Lenders When Applying for a Mortgage Loan?

Your credit score might just be a number, but those three digits hold significant influence over your life, from buying a car to getting a job to buying a house. The home buying process, in particular, involves a lot of checks and balances—your credit score being one of the most important.

Mortgage lenders want to see that your financial house is in order, and they use your credit score to determine your creditworthiness. Overall, it's an indication of how risky you are as a borrower and your likelihood of meeting your mortgage payment obligations on time and in full. That’s why individuals with high credit scores are considered a more reasonable risk. Their credit history indicates that they can manage their finances well, and that’s why they tend to get the best mortgage rates in the industry.

On the other hand, the lower your credit score is, the higher the risk you represent to the lender. To offset this risk, a lender may qualify you for a loan with a higher interest rate, which equates to a more expensive mortgage. The lender can recoup more of their investment early on in case you default, and you'll end up paying more over the loan’s life.

Other Than Your Credit Score, What Do Lenders Look at When You Apply for a Mortgage Loan?

Credit History

Your credit score doesn’t tell lenders the whole story about your finances. That’s why lenders pull your credit reports from the three major credit bureaus. So, what are they looking for?

• Delinquent accounts, meaning bills paid over 30 days late
• Foreclosures
• A past bankruptcy
• Credit inquiries from prospective lenders and credit card issuers
• Open loans, revolving credit accounts, and recent credit applications
• Outstanding debts

While one or two blemishes on your credit history might not dissuade a lender from giving you a mortgage, they can affect your interest rate.

Debt-to-Income Ratio (DTI)

A lender is less likely to view you as a risk if you have a good, steady income, as this means you're likely to meet your mortgage obligations every month. But that’s only if your monthly revolving and installment debt payments don't use up too much of this income. Your debt-to-income ratio is a good indication of how much debt you can reasonably take on. If your ratio is high, it can mean that you’re overleveraged and not in a position to take on a mortgage. Depending on the lender, you might face a higher interest rate or have your application denied altogether.

Most lenders recommend maintaining a DTI of around 43% or lower. If your DTI is higher, you might want to pay off some of your existing debts, so you're not overextended when you add a mortgage payment to your monthly expenses.

Down Payment

The rule of thumb is to have enough money saved up to make at least a 20% down payment on a home. A down payment reduces your loan-to-value (LTV) ratio, making you a more attractive borrower because it reduces the risk you’re asking the lender to take on. As such, you might qualify for lower interest rates, which will save you money in the long run.

However, your down payment amount is not set in stone. Depending on your situation, you may qualify for a government-backed loan that allows you to put down very little. There’s always some flexibility.

What Are the Minimum Credit Scores Required by Lenders Per Loan Type?

The minimum credit score you need to qualify for a loan depends on the mortgage type. Typically, loans insured by the federal government have less strict credit requirements because the lender isn’t taking on much risk by lending you money.

Therefore, score requirements differ depending on whether you're applying for a conventional mortgage or loans backed by the Federal Housing Administration (FHA) or the U.S. Department of Veterans Affairs (VA), as shown in the table below.

What Is the Minimum Credit Score Required for First-time Homebuyers?

Many first-time buyers worry that their credit scores are too low to qualify for a mortgage. But, the terms “good” and “bad” are subjective. For a conventional loan, you’ll need a score of at least 620 to qualify for a mortgage.

That's not to say that you can't qualify with a lower score. As mentioned, your credit score isn't the only factor evaluated when applying for a mortgage. Plus, it all depends on the lender and the risk they’re willing to take on. Some lenders are more than willing to work with borrowers with less-than-ideal credit scores.

Every mortgage lender is different—and so is every borrower. Your financial situation is unique to you, and it's entirely possible to find a lender who's willing to work with you. For instance, you might qualify if you're willing to take on higher interest rates or put down more money to lower your LTV.

The Bottom Line

Your credit score is one of the most critical factors affecting the mortgage application process. But it's only a part. You have to have the whole package: a great credit history, low debt, steady income, and sufficient savings for a down payment.

FAQ #1: Does your credit score go down if you apply with more than one lender?

When a mortgage lender pulls your credit score, this counts as a hard inquiry that can cause a temporary drop in your score (usually less than five points). The minor drop shouldn’t be a concern, as credit scoring models recognize shopping for a mortgage as a positive financial move.

Plus, there's usually a grace period that allows you to apply with as many lenders as possible without lowering your score further. That said, the grace period doesn't mean you should apply for credit you don't strictly need, like a new car or credit card, as it typically applies to multiple mortgage applications.

FAQ #2: How can I increase my credit score before applying for a mortgage loan?

Though you can get a mortgage with poor credit, the process is a whole lot easier when your credit score is in good shape. Plus, a 100-point difference could save you thousands of dollars in interest over the loan’s life. Here are three reliable ways you can raise your credit score when you want to buy a home:

• Pay down some debts by reducing your credit card balances
• Dispute credit report errors with each bureau
• Piggyback on someone with great credit by having them add you as an authorized user of their account(s)

Consider a credit-builder loan that will help diversify your credit mix and bump up your score

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