April 17, 2019
Several factors play an important role in the mortgage process when buying a new home. Arguable the most important? Your credit.
We are accustomed to our credit impacting things like interest rates on our auto loans or approval for new credit cards. But just how does your credit affect the mortgage application process?
Your Credit History
Your credit report is a representation of your last seven years of financial activity. It shows lenders how you have managed past accounts and how you are currently handling debt. It also demonstrates to them whether you’ve been consistent in paying your bills and maintaining healthy financial relationships, or if you’ve hit rough patches.
When a potential lender pulls your credit, they will see all active accounts that you currently hold, credit cards you carry, any liens or judgments against you, and the number of inquiries you’ve had in the last two years. Your credit history will also be used to calculate your credit score; this number plays a significant role in the mortgage loan you’re trying to get.
The Mortgage Application Process
When you apply for a home loan, there are several stages. Depending on the lender, the first step may be a pre-qualification for the mortgage.
Some mortgage lenders will offer to pre-qualify you for a home loan, based on what’s called a soft inquiry. This allows them to see a snapshot of your financial activity and credit scores, to see if you qualify for a loan (and how much they can safely lend you). If you qualify, the lender may give you a tentative loan pre-approval offer, which you can utilize throughout your house-hunting.
Before moving forward with the process, though, lenders will request a hard credit pull. This gives them access to your full report and history, credit scores, and more.
They will use this information to determine whether you truly qualify for a loan and how risky you will be as a borrower. Lenders will also use this to calculate the interest rates you’re offered and even the down payment required.
If You’re Approved
Congrats, you’re approved for a home mortgage! Now, how can you expect to see your credit history impact this new loan?
The traditional mortgage down payment is 20 percent. If you want to hand over less, you’ll need a strong credit score.
VA loans (designed for active-duty military/veterans) don’t require a down payment at all, but in order to qualify, you’ll need a credit score of 620-640 or higher. Some conventional lenders will accept down payments as low as 3 percent, though the typical range is 5-20 percent. In order to qualify for these lower down payment options, you’ll need healthy credit.
FHA loans are available to buyers with lower credit scores. They are backed by the government, and offer down payment options as low as 3.5 percent. However, borrowers will be required to purchase pricey mortgage insurance, making them a less-enticing option.
The better your credit, the better your interest rate will be. This is the case with almost every loan product, but mortgage rates weigh particularly heavily on credit scores.
The minimum credit score needed to be approved for most conventional mortgage loans is 620. However, the average credit score for all successfully-completed mortgages is about 720.
Want to pay less in interest over the course of your loan, qualify for additional loan options, and even enjoy the flexibility of a lower down payment on a conventional loan? You’re going to need good credit.
Improving Your Credit
Having good enough credit to qualify for a mortgage can be easier said than done. But with a little due diligence, you can quickly and consistently improve your score.
Here are a few tips for boosting your credit before buying a home:
- Derogatory reports: Avoid late payments, charge-offs, and judgments at all costs. If you have old negative reports on your credit, wait until they age off before applying for a mortgage.
- Reduce debt: If you’re carrying high loan or credit card balances, work to pay them down before buying a home. This will reduce your debt burden, improve your credit utilization percentage, and boost your credit score. Plus, you’ll have a more flexible cash flow!
- Create a healthy mix: Lenders are wary about giving money to newbies. If your credit report is sparse or only has credit cards, you need to work at improving your credit mix. This might mean adding an installment loan or giving your history more time to build.
- Don’t open anything new: In the year or two before you apply for a mortgage, stop opening new accounts. These will temporarily drop your score, add inquiries to your report, and can indicate that your financial situation isn’t stable… leading to mortgage denials or higher rates.
Aside from knowing what you can actually afford, your credit is one of the most important parts of the mortgage application process. Start polishing your credit report long before you’re ready to buy -- this could save you heartache, and thousands of dollars, along the way!