How Your Credit Score Can Impact Loan Options

How Your Credit Score Can Impact Loan Options

How to Get the Best Mortgage Series  –  Week 4

Follow this series to learn how to get the best mortgage for your specific financial situation and goals. You’ll see what steps you need to take throughout this process to make it productive and successful.

This week you’ll learn why your credit score is one of the key factors that we look at to determine which mortgage products you’ll qualify for along with the interest rate you may be offered. Having a higher credit score may open up more options and products for you, but there are a lot of programs out there even if you don’t have ‘perfect’ credit. Plus, there are always ways that we can help you improve your score!

If you’re even thinking about buying a home in the coming year, now is the time to start giving your credit score the attention it deserves. It can be considered your “one ticket” to homeownership. You want to clearly understand its importance in getting a good mortgage.

FICO Recap

We use your FICO credit score to determine how “risky” you are based on your past financial behavior. We want to make sure you can pay back your loan in full and on time.

Your score is based on information from your credit report, which is kind of like a “report card” on your financial behavior when dealing with credit. It can range from a high of 850 to a low of 300. Your past payment history and total debt (how much you owe) weigh in on its calculation.  Your score also takes into consideration how long you’ve had credit, any new credit, and the type of credit.

Remember, a credit score has nothing to do with your income or investments. It’s based on how you’ve handled your credit card payments and also other loan payments, like your car or student loan.  It also takes into account if you’ve declared bankruptcy, have a tax lien, or you’re being sought by a collection agency.

Credit Scores and Mortgage Options

Let’s look at credit score ranges and what impact they have on your loan options today. Remember, the higher your credit score the more options you have.

740 and above. You’ll have the most options in this range. Conventional loans with a lower down payment may make more sense because the cost of the mortgage insurance is risk based with conventional financing. With a 740 or higher credit score, mortgage insurance is less expensive. FHA, VA, and USDA loans are all also options with this credit score.

720-739. You still have plenty of options if your credit score is here. This is still considered a ‘good’ credit score. Conventional, FHA, VA and USDA are all options, along with many of the first time home buyer programs.

680 – 719. This score is still considered good. All loan options above are still available, however because the cost of the mortgage insurance on conventional financing is more risk based, it could get a bit more expensive unless you are putting down a sizeable down payment. This is typically the credit score range that it becomes more cost effective to use FHA financing over conventional financing with the minimum down. Remember, there is no one-size-fits all, which is why it is best for us to review all your options together!

640-660. This is considered a fair score. Our current minimum credit score is a 640 (Prior to the pandemic, we were able to go down to a 580 with compensating factors.) In my opinion, the government loans (FHA, VA, USDA) will make the most financial sense with a credit score in this range.

Below 640. This is considered a Poor credit score. If you’re credit score is below a 640, don’t give up! Many of my clients have a credit score under a 640 when we have our first conversation. I can give you specific pointers on what you need to do to improve your credit if homeownership is your goal.

It’s Not Over Until It’s Over

For those of you with a lower score than you’d like, don’t give up! Some lenders will have lower credit score requirements than others, and requirements can change over time.

I am always happy to review your credit report with you and provide recommendations to improve your score.

Even though your credit score is weighed heavily when applying for a mortgage, it is only one piece of the qualification process. Other factors that lenders look at include your savings, total assets, current income, and current recurring debt.

Sometimes we can even help you “rescore” your credit and help you with what exactly to do (and not do) to increase your score quickly.  Sometimes it can be as simple as paying a small debt off.

Here are some compensating factors and other file items that could help round out your own credit-worthiness:

• Prove a year of on-time rent payments to show you’ve been a responsible renter and can handle a mortgage payment equal to or greater than the new proposed mortgage payment.
• Provide a letter of explanation that it wasn’t irresponsible past actions but rather specific situations that caused your score to dip — such as losing a job in the recession, large medical bills, or student loans.
• Have a good current debt-to-income ratio.
• Make a larger down payment, usually 10% down or more
• Have at least 3 months of cash reserves in the bank.
• Show you have the potential for increased earnings documented by job training
• Show that there is other income received regularly that is not being used in the pre-quaification

Keep in mind, that even if you get a loan with a higher rate than you would like initially, you can always refinance once your credit has improved. But remember to always weigh the cost of refinancing with the benefit of a new rate over the length of the loan.

How to Increase Your Score Quickly

Even simple actions can help improve (or damage) your score. It’s a step-by-step approach but start working on it today. If you can raise your score from 620 to 700, you will save thousands of dollars in paying interest or mortgage insurance over the life of your loan. Here’s what you can do:

•Make payments on time … all the time. No matter if it’s a few dollars or thousands, a late payment will hurt your score. This makes up 35% of your FICO score.

•Ask for a higher credit limit on your cards but maintain a low balance.  The credit bureaus want to see that you have available credit you aren’t using. Keep your debt-to-credit ratio at 30% or better. This make up 30% of your score.

•Never make major purchases during the time of your loan process. It looks like you are racking up new debt.

•Think twice before canceling a credit card you’ve had a long time.  It shows you’ve built a positive account record over the years. This makes up 15% of your score.

• Negotiate with creditors to make a “good-will adjustment” if you’ve been a good customer in the past. If you’ve just had one or two late payments because of unemployment or other circumstances, they may work with you and remove the late payment. Keep in mind that this is not a guarantee.

•Look out for errors or anything suspicious on your credit report. Monitor your report regularly since small discrepancies can lower your score! You can get a free copy of your credit report once per year from each credit bureau at www.annualcreditreport.com

•Pay off “trivial fines” before they go to a collection agency. Make sure your parking tickets and even library fines are paid!

Let me know if you have any questions about your credit score.  And, last thing—don’t let the fear of not knowing what your credit score is derail you.  Reach out to me and I can take a look at your credit, see what I can recommend to help improve your score, or tell you what the options look like with the score you have.  It’s likely better than you might think!