There used to be a time when owning a home was only within the reach of a few people because it required ready cash to acquire any property. This used to be the picture in America in the 1930s when only 25% of Americans were homeowners. Over the years, the picture has changed dramatically, and today you will find fewer people who do not have a home of their own. This massive transformation has been possible due to the easy availability of home loans or mortgage loans created exclusively for enabling people to become homeowners with minimal investment. Today, most people buy homes by using mortgage loans, and it will not be wrong to say that mortgage is the primary funding choice for aspiring homeowners.
As they say, if you have the will there is always a way, and this most evident in the way mortgage loans have stood by homeowners and helped them to realize their dreams of owning a home. Usually, the bank or the home financing company is ready to offer 80 percent of the property value as a loan by ensuring that the property itself becomes the collateral. Borrowers must pay back the loan over a certain period by choosing 10, 15, 20, 25, or 30 years, so that it is most affordable. The interest payable on the loan will depend on various factors like loan amount and term, but most importantly on the credit score of borrowers.
Understanding credit score
Besides influencing your eligibility for a mortgage loan, your credit score impacts the interest charged by lenders. Better the credit score lower will be the interest. Since the interest determines the cost of the loan, for availing cheaper home loans, you must ensure that you have a good credit score which relates to good credit history. Before you set out to buy a house, check your credit score first so that you are sure of loan eligibility that helps to create a budget. Most lenders refer to FICO credit score issued by Fair Isaac Corporation although Equifax, Experian, and Trans Union are the other agencies that monitor credit scores and provide reports.
The credit score agencies use a scale ranging from 300 to 850 to compute credit scores with higher scores meaning least risks for lenders and vice versa. Scores above 800 are exceptional, very good if the score is between 740-799, good if it is between 670 and 739, fair if it is between 580 and 669 and below 579 is poor.
Besides approaching the credit rating agencies for your credit report anytime, you can also obtain a free credit report from the government once in every 12 months mulled from the reports generated by the agencies.
Credit score requirement
While you must have a good credit score to impress lenders and earn lower interest, there is no minimum credit requirement of credit score that you can treat as standard. It varies according to the type of loan you want to avail. Prior to 2007-2008, it was not difficult for people to avail loans with poor credit, but since the enactment of the Dodd-Frank Law for Wall Street reform in 2010, the requirements of the mortgage industry have become more stringent. Qualifying for a loan has now become somewhat difficult especially for people with less than satisfactory credit score.
Credit score requirements for different types of loans
- Conventional loans – Credit score of 620 might look quite dismal, but it does not bar you from availing conventional loans as many lenders accept the credit score for awarding loan but impose additional requirements like ensuring lower outstanding debt. According to the loan savings calendar available at myFICO.com, a credit score in the range of 620-639 would attract interest rate (APR) of 5.759% which translates into $1,168 per month for a loan of $200,000 with 30 years term. For the same loan amount and term but a FICO score in the range of 760-850, the APR would be 4.17% equating to $975 per month. The total impact of the difference between APR over 30 years works to a big sum of $69,751. This example should help to understand how a credit score can impact home buyers.
- FHA loans – Those who do not have a fair credit score or interested in low down payment would benefit from loans guaranteed by The Federal Housing Administration (FHA). People with a credit score between 500 and 579 can qualify for FHA loan with 10% down payment but having credit score 680 and above they should qualify to avail down payment as low as 3.5%.
- USDA loans – Borrowers with low to moderate income can avail the USDA loan backed by the US Department of Agriculture provided they set up homes in rural areas. To qualify for USDA loans, borrowers must have minimum credit score 640, but sometimes lower credit score can be considered after doing additional credit analysis of borrowers. But whether to accept a lower credit score or not is the discretion of the lender.
- VA loans – Active and veteran military personnel and their families qualify for VA loans that have the backing of the Department of Veterans Affairs. Although the government does not stipulate any requirement of credit score, many lenders prefer only to invite borrowers with a credit score of 620 and above.
- Jumbo loans – Those who wish to avail a higher amount of loan than the permissible limit would benefit from this type of loan, but you need a solid credit score to get through easily. Those with a poor credit score will find it almost impossible to get such loans. Since higher loan amount increases the risks of lenders, they prefer to select borrowers with a credit score of 720 and above.
Finally, it becomes clear that even if it is possible to qualify for some kind of loan with poor credit, it will come at some heavy cost by way of high interest. In order to avail loans with affordable monthly repayment, one must look for a lower interest which means they must impress lenders with better credit score to achieve their goal. And herein is the importance of credit score for mortgage loans.