A Complete Guide on How Does Credit Score Affect Home Loans

Want to know, how does credit score affect home loan? Well, your credit score is, without a doubt, one of the most important factors when it comes to your home loan. The reason is that your FICO score rating reflects your ability to pay back a mortgage.

Good credit boosts your chances of qualifying for a home loan because it shows the loan lender that you’re capable of repaying your loan on time. Your credit score works on the FICO scoring model and reflects your credit reports — compiled by credit reporting companies. And, your credit report includes a history of your payment habits (record of on-time payments to creditors) in the past.

Not only that, your credit score influences your monthly payment and your total interest on the mortgage loan. Basically, it affects the total amount you pay for your home. 

The general rule of thumb is that the higher the FICO credit score, the easier it is to get a home loan, and the lower will be your mortgage interest rates. It goes without saying that keeping your credit score in the best shape possible before applying for any type of home loan, including a home mortgage, should be a priority.

Buying a home is an expensive affair. You don’t want to make it even more expensive by having a credit score that’s less than perfect.

In this article, we’ll show you how your credit score is related to your home loan and what you can do to improve your credit score. Only then will you be able to decrease your mortgage rate.

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What is a good credit score?

The FICO scoring model has different ranges that determine your credit score rating. Generally score from 580 to 669 is considered a fair credit, a score from 670 to 739 is considered good credit, a score from 740 to 799 is considered very good credit, and anything upward of 800 is excellent credit.

Read more: How to Get a Home Loan With Bad Credit Score?

How to improve your credit score

If your credit score is less than perfect, you needn’t feel dejected. The first step is to check for any errors on your credit report and fix them. If your score is indeed low, there are certain ways that will improve your credit score. 

• Make your payments on time, including rent payment, credit card payment, student loan payment as well as a car loan payment.
• Open new credit accounts only if actually needed.
• Restrict your spending to less than 30% of your credit card limit.
• Pay down high-balance credit cards as soon as possible.
• You may consider balance transfers to pay back any credit.
• Inquire for available mortgage rates within a 30-day period. 
• Don’t have too many inquiries — spread out over a long time — as it can lower your credit score.
• Consult a credit counselor on how to build your credit.

How quickly can I improve my credit score?

If you follow the steps to improve your credit score conscientiously, you can see the difference by a few points within a few weeks. Interestingly, you can build a credit score from scratch in about a month. Having said that, any significant credit score improvement is best measured in months and years. Exactly how long it will take for your rating to go up depends on your starting credit score. 

Read more: How Long Does It Take To Improve Your Credit Score

Does mortgage application affect credit score?

Yes. The reason is that, when you apply for a mortgage loan, the lender will check your credit for the loan approval. This triggers a hard credit inquiry that can temporarily lower your credit score — even if it’s just by a few points. 

Moreover, if you’re shopping for mortgage rates, you should do so within a 30-day period. Too many loan inquiries, spread out over a long time, can lower your credit score.

Read more: Paying minimum hurt credit score

Does having a mortgage help credit score?

A mortgage will hurt your credit score temporarily — until you show an ability to pay back the loan. If you pay your mortgage payments on time consistently and keep your debt-to-income ratio at a reasonable level, you can bring up your credit score.

The minimum credit score you require for qualifying for a mortgage and buying a house depends on the type of mortgage you are seeking. For example, in the case of conventional loans such as Fannie Mae and Freddie Mac, there’s a lot of focus on your credit score.

However, for government-backed loans such as the Federal Housing Administration (FHA loans), Department of Veterans Affairs loans (VA loans), the Agriculture Department loan (USDA loans), there is some leniency on credit scores and underwriting guidelines. 

The only downside to such types of loans is that the loan fees are expensive. Plus, you need to pay private mortgage insurance (PMI) for an FHA loan. Ironically, your credit history will affect the private mortgage insurance rates too. So, there’s no escaping from a bad credit!

Read more: Improve your credit score

How does your credit history affect your loan-to-value ratio (LTV)?

In the mortgage industry, your loan-to-value ratio is the percentage of your property sale price – or the appraised value in a mortgage refinance – up to which, you will be able to borrow money. And, not surprisingly, your credit history often affects how much you can borrow on a given property.

If your credit scores are below a certain level, mortgage lenders tend to limit how high they’ll go on the LTV. For example, while you can borrow up to 95% of your property value if you have a very good credit score, you may be able to borrow no more than 80% of your property value if your credit score is 650. A low score translates to a bigger risk for the loan lender. 

Read more: How to Get Bad Credit Mortgage Loans

Last words

Now you know, how does credit score affect home loan or your chances of loan approval. The fact is that without a high credit score, you won’t be able to qualify for the best mortgage rates available. Chances are, you’ll end up paying more money over the entire loan term.

Lenders rely on your credit scores to determine whether you’ll be able to meet obligations. A higher credit score gives them the assurance that the loan amount will be paid back.

Read more: What is TRID in real estate?

Written by Ramona Sinha. December 31, 2020

Ramona is a content writer for Kukun. This experienced blogger uses simple and succinct words to decipher the complex phenomenon called life. An avid traveler, she’s a digital nomad at heart and an animal lover from the depths of her soul.