Whether a homebuyer is looking to apply for an FHA loan, a conventional fixed-rate mortgage, or an adjustable-rate mortgage (ARM), there is one inevitable detail that impacts qualification for any loan: credit score. This along with debt-to-income (DTI) ratio are just two of the things lenders look into when assessing financial risks and determining a borrower’s reliability in being able to make monthly payments on time.
What Is a Credit Score?
A credit score is defined by FICO as a number ranging between 300 and 850 that measures a borrower’s suitability to receive financial credit. This score is impacted by the borrower’s credit report, which looks at the number of accounts open, repayment history, how much debt is owed and for how long. A borrower’s credit report also looks at the types of credit they have, including any new credit, and any bankruptcies.
With all that goes into a credit report and how this impacts credit score, which scores are considered a good range? The different score ranges are defined as follows:
- Excellent: 800 – 850
- Very Good: 740 – 799
- Good: 670 – 739
- Fair: 580 – 669
- Poor: 300 – 579
While many lenders will approve loans with a minimum credit score of 620, many lenders prefer a credit score of 700 or higher.
Why Is Credit Score So Important?
As mentioned earlier, a borrower’s credit score is used by lenders to assess any potential financial risks to themselves, as well as the reliability of the borrower to make monthly payments on time. As such, credit scores ranging from good to excellent tend to be ideal for lenders because it minimizes the likelihood of potential losses for them.
A good to excellent credit score also informs the terms and conditions of the loan itself, which is why borrowers with higher credit scores tend to get better deals on their loans like lower interest rates and lower down payment options. While borrowers with fair credit scores can still get approved for loans, the terms and conditions will not be the same as a borrower with a higher credit score. For example, borrowers with a fair credit score will typically pay slightly higher interest rates and make slightly higher low down payments.
How Can a Credit Score be Improved?
Knowing how much a homebuyer’s credit score impacts their ability to qualify for a mortgage, there are several ways to improve it. One very simple way is for homebuyers to always monitor their credit scores and to review their credit reports for any errors. One great resource is annualcreditreport.com, which allows users to check their credit reports for free once a year.
Another good way for a homebuyer to improve their credit score is to avoid late payments on existing accounts. Since payment history has a significant impact on credit score by at least 35%, making consistent monthly payments helps maintain the score in the higher ranges. Another good practice – especially in the case of credit card debt – is to keep balances low and pay them off in full every month. In cases where credit cards have reached their maximum limit, pay more than the minimum each month to help bring the balance down to at least 30% of the card’s limit.
Another major factor that impacts credit score is the number of open accounts. Keeping older accounts open even when they’re no longer in use is ideal for lenders because it allows them to see how long those accounts have been around. Not closing credit card accounts while there’s still an existing balance on other cards is also best as closing them could actually lower the score. If there are any delinquencies on an account, they need to be resolved as quickly as possible.
On the subject of credit card debt, one option homebuyers can consider if they want to pay down a balance faster is taking out a debt consolidation loan as it lowers the number of payments to one and can offer a lower interest rate. Another option is a balance transfer credit card, which works similar to a debt consolidation loan and can have a promotional period of 0% interest. One thing to be aware of, however, is to not have too many credit accounts open as this can also lower the credit score.
To learn more about how MCS Mortgage can qualify you for a loan based on your credit score, feel free to contact us by phone at 833-415-LOAN or by email at Hello@MCSMLS.com.