Minimum Credit Score for Buying a House
Buying a house is one of the most important things you will do. For the vast majority of Americans, it’s the biggest purchase they will ever make and a preface to a major change in their life. It’s not something to be taken lightly, but it’s something that millions of Americans struggle with.
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Credit scores are on the rise, but the average age of first-time buyers is decreasing, triggering a housing crisis that is causing great stress for countless families. One of the biggest issues is that mortgage lenders are much stricter than they used to be and although scores are better, demands have increased and many Americans simply don’t meet the necessary criteria.
Home Loans and Your Credit Score
A higher credit score is always preferable, but there’s a point at which it won’t make that much of a difference. Where mortgages are concerned, a good credit score is generally anything above 700 and most mortgage lenders will be satisfied with this. If you drop below this ideal range, however, you may struggle.
Credit score requirements differ from lender to lender and good credit to one may be bad credit to another. However, you’ll generally be accepted if your score is between 660 and 700, but the rates you’ll be offered may be considerably worse than the rates you get with a plus-700 score.
Anything under 660 may be classed as “Fair” by credit card and auto loan lenders, but where mortgage lenders are concerned it’s bad credit and may result in a point-blank refusal.
This is not a huge issue, however, as you just need to raise your credit score by a few points, work on your debt-to-income ratio, and your suitability will improve significantly in their eyes.
You can also apply for bad credit home loans, also known as subprime loans, although unless you have a history of late payments, bankruptcy, and damage that isn’t going to be undone anytime soon, it’s always best to work on improving your credit report before committing to any long-term high-interest loans.
Understanding Mortgage Payments
Two main factors affect your monthly payments: The size of the loan and the length of the loan. The longer the term is, the lower your monthly payment will be but the more you will pay back over the lifetime of the mortgage loan.
As an example, let’s assume that you need a mortgage loan of $100,000 in addition to your down payment. If you get a 4% interest rate and opt for a short term of 10-years, then you’ll pay $1,012 a month. This is a huge sum of money for a relatively small mortgage, but it means you’ll only pay back $121,494 for the lifetime of the loan.
To decrease that monthly payment to $477 you can choose to pay over 30 years. However, doing so will add an extra $50,000 to the total cost of the mortgage.
These mortgage payments cover both the Principal and the Interest, but you also have to factor in taxes and insurance, which are not as easy to calculate.
When you begin your loan, most of the money you pay every month will go towards the interest, with only a small fraction going to the Principal. If you increase your payments, you can clear more of this Principal and greatly reduce the lifespan of the mortgage, which in turn will reduce the total interest that you pay.
What are your Options if your Credit Score is not Good Enough to Buy a House?
You can qualify for a subprime loan if you have a credit score in the 500s. However, as mentioned already, you may want to work on fixing your credit report first as a subprime mortgage loan could increase your interest rate by up to 0.5% when compared to a score of 700 or more.
A mortgage loan of $200,000 taken over 30 years at 4% will cost you $955 a month and you’ll pay back just over $343,000 over those 30 years. Add an extra 0.5% onto that and your monthly payment will increase to $1,013 and you’ll pay over $364,000. And that’s assuming you’re able to nail down a respectable fixed-rate mortgage and meet all monthly payments.
Why is Your Mortgage Rate Higher if you Have Bad Credit?
A mortgage lender takes a massive risk when it provides a bad credit borrower with a loan. It charges a higher rate to recover some of those costs. Of course, if the borrower eventually defaults and a foreclosure is necessary, then the lender will lose out regardless of how high the interest rate is.
But statistics suggest that foreclosures happen just 0.5% of the time. If lenders take additional money from all borrowers with low credit scores, those profits will help to offset the inevitable losses that occur when a small percentage of those borrowers default. This isn’t as big of an issue for someone with a good credit score, so lenders reward them in kind.
In essence, if you have a bad credit score then you’re being punished because you’re more likely to default then someone with a good credit score.
How Much do Mortgage Lenders Lose on a Foreclosure?
You could be forgiven for thinking that mortgages should be easier to acquire than a brand new credit card or a substantial debt consolidation loan, especially if the borrower has no late payments and a respectable credit history. After all, the bank gets a sizeable down payment, they earn huge sums of money in interest, and if it all goes wrong, they can just repossess the house and get their money back.
Simple, right? Not really, because foreclosures are not cheap. Far from it.
According to official statistics, mortgage companies lost $0.20 to $0.60 on the dollar for every foreclosure, with an average loss of $50,000 per house. That may not sound like a lot, but the average purchase is $235,000 with a 10% down payment, which means the average mortgage is just over $211,000. In other words, lenders are losing an average of 23.6% per foreclosure.
There are a lot of fees involved with this process, including up to $34,000 lost on government agencies as the lender is required to cover court actions, inspections, unpaid utility bills, and a whole host of other ordinance costs.
And that’s before the house goes to market and is inevitably sold at a huge loss.
Although it’s easy to think the worst and assume that collecting home loan payments for a few years and then entering into foreclosure is the best outcome for lenders, it really isn’t. They don’t stand to lose quite as much as the borrower who has just been forced out onto the street, but there is a significant financial burden to bear.
Why is it Harder for First-Time Homebuyers?
First-time homebuyers struggle because they lack the collateral. If you’re buying your second home then you have a home to sell, which means you can afford a larger down payment and have a credit report that shows years of mortgage payments. Cash may be easier to come by and lenders may be more trusting and willing.
First-time homebuyers rarely have anything bigger than a credit card or personal loan on their credit report. Acquiring enough money to cover the down payment can also be difficult.
According to statistics from a leading realtor website, over half of all first-time buyers have been searching for a home for more than 6 months, with the main issue being that they can’t find a suitable home within their budget.
The Factors that Affect your Credit Score the Most
Fixing your credit score is clearly the way to go if you’re being refused a home loan or simply want a better rate. You can check your credit report with one of the three major credit bureaus (TransUnion, Experian, Equifax) to see where you stand currently. If your score is suffering immensely, then it’s likely to be the result of one of the following issues:
- Fraud: In 2017 and 2018 there were over 13,000 data breaches spanning sites big and small. These breaches farm user data and sell it to fraudsters who use it to assume a victim’s identity. This is becoming increasingly common, and if it happens to you then you could see a wealth of inquiries, accounts, and debts that have nothing to do with you. Fortunately, you can dispute it and get the issue cleared up.
- Late Payments: If you miss payments, a mark will appear on your credit report. Payment history accounts for more of your score than anything else, and the more of these late payments there are, the more your score will drop. It’s imperative that you pay on time, regardless of the size or assumed importance of the debt.
- Derogatory Marks: Collections, Bankruptcy, Delinquencies—all of these can display derogatory marks, which remain on your credit report for between 7 and 10 years, seriously affecting your chances of getting a mortgage loan.
- Poor Credit Utilization: You should aim to use less than 30% of your available credit. If you have a combined credit limit of $10,000, this means you should use no more than $3,000. If your credit utilization ratio climbs higher, your score will drop. If it goes anywhere above 50%, it will plummet and take your chances of getting a mortgage with it.
Lifestyle Changes you Can Make to Improve your Credit
There are a lot of things you can do to improve your credit and increase your chances of getting a mortgage. These take time, but if you keep a close eye on your credit report you’ll see the changes from month to month and will have the motivation you need to continue:
- Pay Your Bills on Time: Doing so will gradually improve your score, but most importantly it will prevent your score from nose-diving if any payments are missed.
- Eat Out Less: The average US household spends over $3,000 a year eating out and wastes around $100 to $200 a month on spoiled food. Shop only for what you need and only eat out on special occasions.
- Sell-up: CDs, DVDs, video games, designer clothes, instruments, books—the average household is sitting on a goldmine of unwanted items that could be sold on widely available marketplace sites and apps.
- Stop Gambling and Smoking: Smokers spend an average of $300 a month on cigarettes and over $200 on lottery tickets. That’s $500 down the drain that could be used to clear debts.
- Budget: Create a detailed budget that records all of your incomings and outgoings, making sure every cent is accounted for and giving you an idea of just how much you’re wasting.
- Clear Debts: If you have any extra cash at the end of the month, use it to clear your debts or at least take a large chunk out of them. It’s not all-or-nothing, the more you can pay, the better, because it will improve your score and reduce your total interest payments. This applies to loan debt as well as credit cards. Use savings, investments, and any money you save or acquire by selling used items.
Summary: A Good Credit Score is Worth the Effort
Millions of Americans are desperate to purchase their first homes. They scrape together whatever money they can find, make commitments they know they can’t afford and prepare to accept mortgage rates that will penalize them for years to come. It’s hard to stay patient, but the best thing you can do in this situation is sit back, work on building your credit score, and then wait for the lenders to come to you.
Getting a mortgage is so much easier and cheaper when you have a credit score of 660 or higher and it gets even easier if you climb above 700. The amount you could save just by spending a few months rebuilding is well worth waiting for, so don’t rush in!