Houses are expensive, which is why it is no surprise that more than 62% of American homeowners have a mortgage. Taking out a mortgage is one of the biggest decisions you will ever make, and it has to be done correctly to avoid financial catastrophe.
One factor that is often overlooked is your credit score, which plays a major role in your search. Luckily, there are things you can do about it. Let us talk about a good credit score for mortgage seekers, what it is, and how you can improve yours.
Understanding Credit Scores
Your credit score is based on a scale of 300 to 850 with 300 being the worst possible score and 850 being the best possible. Here is what you need to know about it before we talk mortgages!
First, let us define "good credit". It is highly unlikely you will ever see a score of 850, or even in the 800s. A score of 750 and up is considered excellent, although some would argue 720 or even 760 is excellent.
However, a score above 750 puts you in an elite group of borrowers. These are people with no derogatory marks, consistent on-time payments, and usually a healthy credit mix. If your score is above 750, you can expect to find a loan relative to your income.
A score between 680 and 750 is considered good credit. Let us say your credit score is 710. In that case, you will not have a difficult time finding loans proportionate to your income, but your interest rate will likely exceed that of someone with an excellent credit rating.
Although it is a wide range, between 580 and 680 is the average, which is considered fair credit. Ideally, you want to avoid the 500s altogether; however, this range is where you will start to find difficulty borrowing, especially for large loans like mortgages.
Once you go below 580, you can expect trouble finding lenders who are willing to lend to you. Anywhere from 300 to 500s is considered bad credit.
Factors of Credit Score
If we understand the factors that affect our credit, we can always work to improve on them. There are 5 key factors that determine your credit score.
First, and most important, is your payment history. Being a couple of days late on a payment is no big deal, as you will only owe a late fee, but once it exceeds 30 days, it will affect your score.
Payment history accounts for 35% of your entire score, so one missed payment on an otherwise good record could bring your score down by over 100 points, especially if your credit is fairly new. These marks will stay on your score for up to 7 years, so missing a single payment will have a devastating impact.
Next is credit utilization, which accounts for 30% of your score. Depending on the types of revolving credit you have (credit cards, home equity lines, etc.), you want to keep the total owed amount under a certain percentage (ideally 10%).
Consequently, if your credit limit is $17,000, you want to keep your debts on there under $1,700 for the best results; however, 20% and under will not have an effect on your score, but keeping it under 50% at all costs is most important. It is okay to spend over 20% of your credit limit, as long as you are not leaving that balance on your card at the time of your statement.
Well, the average American has over $6,100 in credit card debt, so if you are close to the average, paying it off should be your first step.
For the next ones, we have both credit mix and length of credit. The average length of your credit history accounts for around 15% of your score, but the only way to boost it is with time. If you only have 2 years on your credit history, it makes lenders uneasy, which is one reason why millennial homebuyers have so much trouble.
However, when you show that you can safely manage your debts over the course of 5 to 10 years, lenders appreciate it. Keep your credit cards open and in good standing for as long as possible to help boost this aspect.
Credit mix refers to your mix of revolving and termed credit lines, and makes up for around 10% of your score. Hence, if you have a healthy mix of credit cards, student loans, and auto loans, then you are showing creditors that you can handle all different types of debts.
Lastly, we have new credit, which accounts for up to 10% of your score and is mostly determined by hard inquiries. When you open a new loan, a creditor will inquire about your credit history, which will temporarily lower your score.
However, this is not a big deal unless you apply for dozens of new loans all at once. If you have a hard inquiry or two, it may dock your score by a few points temporarily, but it should bounce back in no time. The longest that can last on your score is 2 years, but they usually vanish within a couple of months.
What Is a Good Credit Score for Mortgage?
Remember, it is not just your credit score that affects your ability to find a mortgage loan. Your income, reason for purchasing, and other factors will also play a major role in your eligibility.
However, assuming that you have enough income for the loan that you seek, having a good credit score will help you avoid unnecessary hurdles. Ideally, you want to have an excellent credit rating, but you at least want to aim for 680 before taking out a mortgage.
Let us imagine your credit score is in the mid-500s. We would highly recommend that you work on bringing your score past the 580 or even 600 thresholds before pursuing a mortgage. So, why is it so important?
Why Is Credit Score So Important?
When taking out a mortgage, it is likely to be one of the biggest loans of your life. A house is the largest lifetime purchase for the average American, and there is plenty to look out for when buying, so any opportunity to save money on one is advised.
Let us say you are looking to buy a $300,000 home with a total household income of $80,000. That is not out of reach by any means, assuming you do not have large outstanding debts.
However, with a poor credit score, you could have a difficult time finding a loan for over $200,000 after your down payment. If your downpayment was $50,000, you would need a loan of $250,000 before all of the closing costs, realtor fees, and everything else. In total, you could wind up needing a mortgage of $300,000 even with your down payment.
Even with a stable income, you may find significant trouble landing that mortgage if your credit score is low. If you do find a loan, you are likely to find a high-interest rate. Well, a lower interest rate could save you a small fortune.
"A few percent" may not sound like much, but in the context of a $300,000 loan, the difference between 3% and 8% is $15,000. Would you spend an extra $15,000 on a car if you did not have to?
Not only that, but your credit score could help determine what kind of house you can live in. If there is a neighborhood or town you have wanted to live in or a house you really want, then you want to avoid unnecessary limitations.
Also, with a poor credit score, you may have trouble finding an apartment to rent the same way you have trouble finding a home. Even with a stable income, you could have a lot of difficulties finding housing with poor credit.
How to Boost Your Credit Score
Although we said that having more lines of credit helps your score, opening new lines of credit needlessly is not necessarily going to help you in the short term. Unfortunately, boosting your credit score takes time, which means that putting off buying a home for a bit while you boost your score could save you thousands of dollars.
If you have at least a year before you plan to buy your home, then there is a lot you can do. You can open a new line of credit if you need one or work with what you have. Spend some money on your credit cards, keep your balance under 10%, and pay everything on time.
Let us say your credit score is 650 right now. A lot can happen in a year, so if you are diligent with your debts, not taking on anything you do not need, and making on-time payments, you could get into the "good" range soon enough.
If you are worried about overspending, put your monthly subscriptions like Netflix onto your credit cards and lock them away. From there, pay them off at the end of every month and forget about them. The average American already spends $273 on subscriptions a month, so this could boost your payment history and credit utilization without changing your monthly expenses!
Start Building Today!
Now that you know the importance of a credit score for mortgage seekers, there is no time like the present to start building your credit. The sooner you do, the sooner you can find your dream home! Stay up to date with our latest real estate news and feel free to contact us with any questions!