What’s all this talk about credit scores lately? There’s one group of people telling me I need to maintain a credit score of 700+ in order to save money when I buy a house. Then there’s another group bragging about how they have a “0” credit score, **cough** Dave Ramsey **cough**.
So which one is it? Do I need to spend time trying to understand what a FICO score even is or should I cut up all of my cards and strive to get my credit score to a nonexistent number?
Everyone seems to have an opinion about what they think personal finance should be.
The Minimum Credit Score Needed To Buy A House [the quick answer]
The quick and easy answer to your question is, there is no minimum credit score to buy a house. You can buy a house with a terrible credit score or no score at all.
However, if you are looking to borrow money for your mortgage, there are some general guidelines that lenders look at when deciding whether or not to loan you money. Keep in mind that these are just guidelines and underwriters can make exceptions.
The current state of the economy and the lender’s current financial situation will weigh heavily on how closely a lender looks at your credit score before they decide to take, I mean, lend you money.
Credit Scores And Personal Finance Opinions
There are some guidelines for a minimum credit score needed to buy a house. However, these guidelines are not always set in stone. Later in this article, we will show the recommended minimum scores for the different types of loans.
There is not a one size fits all to credit scores and personal finance. While there are certain mathematical advantages to one strategy over another, we are not mathematical machines. We are people with personalities and have different things that motivate us and hold us accountable.
With that being said, let’s define credit scores and what lenders look at when they make a determination to give you money, and at what rate.
What Is A Credit Score? [Definition]
A credit score also referred to as a FICO score, is a number given to you based on your credit history. This number will generally rise and fall throughout your life and is calculated based on a number of different factors.
FICO scores are used mainly in the lending process. It is a number that lenders refer to in an attempt to determine how big of a risk you are to them. In theory, the lower your credit score, the more likely you are to default or fail to repay a loan.
What Is The Highest Credit Score Possible?
Strictly talking about the FICO credit score system, the highest possible score is 850. However, with all the factors involved in the scoring system, anything over 800 is considered, “perfect.”
While 850 is the highest score possible, this excellent credit score is nearly impossible to achieve. Everything would need to be absolutely perfect as far as the credit score factors are concerned.
If 850 Is The Highest Score, What Is The Lowest?
In contrast to a score of 850, a score of 300 is the lowest possible credit score. However, you may have terrible credit and still be nowhere near 300. A credit score of 300, like that of 850, is nearly impossible to achieve.
Credit Score Scale And Ratings
Now that we know both extremes, let’s look at the traditional FICO score scale to determine what lenders consider “good” credit versus “bad” credit.
According to Investopedia, credit scores fall into the following ranges:
How A Credit Score Is Determined
I understand that your credit score may not quite make sense to you (you’re not alone), so I will explain the five major factors that contribute to your overall credit score. According to myFICO, each category is also weighted differently.
The 5 Categories That Determine Your Credit Score:
- Your payment history (weighted at 35% of your overall score)
- How much debt you have (weighted at 30% of your overall score)
- Your length of credit history (weighted at 15% of your overall score)
- How many new lines of credit have been opened (weighted at 10% of your overall score)
- The types of credit you have open (weighted at 10% of your overall score)
1. Your Payment History (35%)
By far the most important factor in determining your overall credit score is your payment history. Do you always pay your bills on time or do you occasionally (or frequently) make late payments or miss payments altogether?
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Lenders take a good look at your history because history has a way of repeating itself.
2. Your Total Debt (30%)
Lenders actually like to see that you enjoy paying people interest by borrowing money. However, if you have a $10,000 credit card limit and your card balance is at $9,999, that could mean you are one injury away from not being able to pay your bills.
A healthy balance of available credit in relation to how much credit you are currently using is a determining factor in your overall credit score.
3. How Long You Have Had Credit (15%)
Generally, the longer you have had credit, the better your score will be. If you have had a credit card since you were 16 and you still have the same one at age 35, this is considered a good thing. The longer other people have been willing to lend you money, the more reliable you probably are.
4. How Many New Accounts Have Been Opened
Again, lenders are looking at your habits and trying to decide if you are going to pay them back or not. If you recently opened three new credit cards, that sends a red flag to other lenders.
They don’t know why you opened those new accounts and if you’re going to be able to pay back those credit card companies and your new lender if you suddenly start buying things.
A bunch of new accounts all at once can have a significant impact on your score.
5. The Types Of Credit You Currently Have
While there is not a hard and fast algorithm given to how this is determined, know that the types of credit you take out are examined. Your balance of credit lines in the form of credit cards, mortgage, and personal loans are scrutinized.
Guidelines For Credit Scores And Home Loans
As stated earlier, credit scores are a strong indicator of your ability or willingness to repay debt. With that being said, many companies will lend you money no matter what your credit score is.
However, just because someone will lend you money, don’t expect it to be painless. Your credit score is also a big factor for the interest rate you will be charged. The lower the credit score, the higher the interest rate. The reason for this is due to the risk the lender takes by giving money to people who may or may not pay them back.
With increased risk comes increased reward, for the lender. If your credit score is poor, you’re going to pay dearly for it – with interest.
Different Types Of Home Loans
Generally, there are four different types of loans most people obtain in order to buy a house. These loans are:
- Federal Housing Administration Loans (also known as FHA loans)
- Veterans Affairs Loans (also known as VA loans)
- United States Department Of Agricultural Affairs Loans (also known as USDA loans)
- Conventional Loans (loans from private entities not backed by the Federal Government)
Credit Score Needed For A FHA Loan
Unlike the other loans, the FHA loan actually does have a minimum credit score in order to be eligible for the program. Because it’s connected to a federally funded program, there are strict guidelines that you must meet in order to qualify for this loan.
If you are able to provide 10% of the mortgage price as a down payment in cash, you must have a minimum credit score of 500.
If you are only able to put 3.5% down as a down payment, your credit score must be a bit higher – at 580.
Due to the lower down payments needed for FHA loans, they are primarily designed for borrowers who fall into the low or lower-income tiers.
Credit Score Needed For A Veterans Affairs (VA) Loan
If you are a veteran, there is more leniency given for VA loans in regards to credit scores. The minimum credit scores are dependent on each individual lender that is part of this program. Credit score minimums will vary by lender. Due to this, there is no “minimum” credit score for the overall program.
While there are no official minimums, there are a few guidelines for borrowers looking for a home loan. Most of the lenders in the VA program require borrowers to have a minimum credit score of 620. While this a general norm, a few other lenders will lend to borrowers with a credit score of 580 or above.
Credit Score Needed For A United States Department Of Agriculture (USDA) Loan
Similar to the criteria of a VA loan, there is no official minimum credit score needed for a USDA loan. However, the “recommended” minimum credit score for a USDA is 640. Again, this is a recommendation and not to say that you can’t obtain a USDA loan with a lower credit score (but don’t get your hopes up).
Credit Score Needed For A Conventional (Traditional) Loan
Conventional loans usually require a down payment of 20%. As far as minimums, again this depends on each lender but the general guideline is to have a minimum FICO score of 620 to 640.
General Rule Of Thumb For Credit Scores And Home Loans
While credit score minimums vary by lender, the majority of lenders require a FICO score of at least 620, while a credit score of 580 appears to be the absolute lowest under most circumstances.
It is obvious that the higher your credit score, the better chance you have at securing a home loan with a lender.
Keep in mind that your credit score is also tied to the interest rate that will be attached to your loan. Generally, the lower your credit score, the higher the interest rate you will be offered. Interest rates can vary greatly and a percent or two can result in you paying tens of thousands of dollars to the lender over the life of the loan.
Credit Scores And Your Chances Of Getting A Home Loan
As previously discussed, your credit score is a strong indicator for not only your ability to secure a mortgage from a lender but it also influences your interest rate. However, there are other options for you to obtain a mortgage if your credit score is not where it should be.
Home Loan Options For Credit Scores Between 300 And 499
If you have poor credit, you may still be able to secure a home loan. However, you may need to be creative and prepared to pay a higher interest rate.
If you fall into this FICO score range, one option is to have a cosigner help you obtain a loan. A cosigner is someone who will vouch for you and pay the lender back in the event you are unable to repay the loan.
Cosigners generally must have good credit and will go through the same background scrutiny that you do. In this situation, cosigners take on a great deal of risk because they are also responsible for the loan.
Another option is to improve your credit score before you attempt to get a home loan.
Home Loan Options For Credit Scores Between 500 And 579
A FICO score between 500 and 579 begins to open more opportunities for you to obtain a home loan. The programs for people in this range are geared to help people in lower-income brackets and lower credit scores.
FHA loans, for example, are available for people in this credit score range but more than likely will require at least a 10% minimum down payment.
Co-signing is also an option in this situation, but will require a considerable down payment of 20% if a conventional option is sought.
Home Loan Options For Credit Scores Between 580 And 619
If you have a FICO score of 580 or higher, you may qualify for an FHA loan with a 3.5% minimum down payment – much less than the 10% required below a 580 credit score.
In this range, some VA lenders will also open their doors to borrowers because of the improved credit situation.
Home Loan Options For Credit Scores Between 620 And 699
With these higher credit scores, obtaining a home loan becomes easier. For example, in this range, VA loans that require 0% down, become available to you and you may pay a lower interest rate.
In addition to the VA loan, you become eligible for a USDA loan if you have a credit score of 640 or higher.
Finally, conventional loans that require a 20% down payment are generally available to people who have a minimum credit score of 620. The higher credit scores also mean lower interest rates for potential borrowers.
Home Loan Options For Credit Scores Between 700 And 739
These high FICO scores will open the doors to just about every type of home loan and will greatly improve your chances of obtaining the lowest interest rate. Borrowers who have credit in this range have a very good credit history and generally make all of their payments on time.
Home Loan Options For Credit Scores Between 740 And 850
This top tier credit score greatly impacts interest rates and also can influence the amount of Private Mortgage Insurance (PMI) the borrower will pay. PMI is insurance the borrower pays to protect the lender in the event the borrower is unable or unwilling to repay the loan.
PMI is required if the borrower puts a down payment of less than 20%. The cost of PMI is directly tied to FICO scores. For instance, a credit score of 620 will be required to pay PMI equal to 1.1% of the loan amount. A 760 credit score will lower the PMI to a percentage of only 0.3%.
As you can see, higher credit scores will save you significant amounts of money in both interest rates and PMI in the long run.
How To Increase Your FICO Score And Fix Your Credit To Buy A House
If you have less than stellar credit and are having trouble getting approved for a loan, there are several ways to improve your credit score. As previously stated, there are several key factors that go into play to determine your overall credit score.
As a reminder, the key components are:
- Payment History
- Total Debt
- Length Of Credit History
- How Many New Lines Of Credit Have Recently Been Opened
- The Mix Of Your Credit Lines
In order to raise your credit score, make sure you are making all of your payments on time and refrain from opening any new accounts. Pay off debt to lower your overall score and liability to lenders.
Poor Credit May Be A Warning Sign
If you do have a poor credit score, it may be due to the mismanagement of your bills and failing to pay them on time. Debt is a slippery slope and if you already struggle with it, getting a mortgage for hundreds of thousands of dollars may not be in your best interest.
Avoid punishing your future self by taking on a major debt you may not be able to pay back. There is nothing wrong with renting, especially if you need to spend a little extra time improving your credit score and your financial habits.
Your credit score is often a direct reflection of your overall personal finance ability. Don’t ruin your life by burdening yourself with additional debt. Get back to the basics and teach yourself the basics in personal finance by checking out my Debt Payoff Playbook.
The highest FICO credit score possible is 850. However, any score higher than 800 is considered “perfect.”
The lowest FICO credit score possible is 300. However, this low score is nearly impossible to achieve.
A score of 800 or more is considered “excellent.”
A score between 740 and 799 is considered “very good.”
A score between 670 and 739 is considered “good.”
A score between 580 and 669 is considered “fair.”
A score between 300 and 579 is considered “poor.”