Credit, credit scores, and the role these both play in home loans are all often the source of a lot of confusion among borrowers. And it’s easy to see why. With credit scores not being readily available and credit worthiness often being determined by seemingly mysterious factors, it’s no wonder we at Crystal Clear Mortgage are so frequently asked about how credit factors into the home loan process.
And yes, it can be complex – but not impossible to understand. We’re here to help clear the confusion.
First of all, what is credit?
For someone just starting out financially, it may be all about getting that first credit card and making payments on time. But generally speaking, credit is a borrower’s ability to both borrow and then repay debt. This can be debt from a revolving type of credit, like a credit card or line of credit, or a term loan, like an auto loan or personal loan.
By reliably making payments on time, a borrower can establish good credit. But this isn’t all that matters. A person also builds good credit by balancing credit available with credit used. This means that the borrower doesn’t “max out” loans and credit cards but always has a healthy amount of credit available. Variety also matters. Lenders like to see that a borrower has experience with both revolving credit and term loans. Other considerations include recently closed accounts. Many borrowers make the mistake of closing credit accounts when paid off so they won’t be tempted to use them. The problem is this makes the borrower look like he or she doesn’t have much credit available, which can be interpreted by lenders as a lack of creditworthiness. A few good rules of thumb to keep in mind, then, are to develop a track record of on-time payments with a variety of credit types, to always have some open credit available to you, and to avoid closing credit accounts immediately before applying for new loans.
Your experience with credit is then boiled down to something called a credit score. The most widely used credit score is the FICO score. Named after the Fair Isaac Corporation, the FICO score ranges from a low of 300 to a high of 850. Generally speaking, a score of 670 or higher is considered good, while a score of 800 or above is exceptional – though many lenders set their own parameters. Credit scores give lenders a snapshot at a glance of your creditworthiness and helps them customize loan options more efficiently.
For a home buyer, your credit and credit score can have a big impact on your home loan. Credit requirements are most stringent for conventional home loans, though every lender has different requirements. Borrowers not meeting credit requirements for conventional mortgage loans may still be able to get an FHA loan, which is backed by the Federal Housing Administration. And the Department of Veterans’ Affairs has no minimum credit score for the home loans it guarantees, though obviously military service and other qualifications apply.
Your credit score can also have an effect on your home loan finance rate. Those with higher credit scores qualify for the lowest rates. For this reason, it’s always best to take steps toward improving your credit if you think – or hope! – that buying a home is in your future.