It is widely understood that good credit scores help you get the best possible rate for your home loan, but you may be surprised at the options available even if your scores are not perfect. Understanding how credit scores are calculated will help you improve your score before you buy your first home.
Credit scores can range from 300 to 850. The higher the score, the more confident a lender can be that the borrower will be able to repay a loan. Higher scores can sometimes help you get lower interest rates on certain loans. There are five key factors in determining a credit score:
1 - Payment history
Do you pay all bills on time, especially the ones that report to credit bureaus? These include credit cards, car payments, student loan payments, etc. Your credit will not be ruined if you are a few days late, but try to never be more than 30 days late. Late payments can stay on your credit report up to seven years.
Most utilities don’t report to credit bureaus, so if you have been late on those in the past, they probably don’t affect your score. But it will be important to pay these on time going forward so they do not go to collection services.
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2 - Credit utilization / total debt
The more debt you have, the more difficult it could be to pay your home loan. So lenders are very cautious if you have too much debt.
For revolving credit – like credit cards -- you don’t want the balances to be too high in relation to your card limit. A good rule of thumb is to keep your credit card balances below 10% of your credit limit. For example, a credit card with a $2,000 limit should have a balance of $200 or less when your credit is checked for a home loan.
If your credit cards are over the limit or you have reached your credit limit, pay them down a bit before having your credit checked for a loan. Allow 30-45 days after you pay them down before having a credit check. If you can’t pay down to 10%, then try to get below these thresholds: 70%, 50%, or 30%. These will impact your credit score.
3 - Credit history length
Credit scores factor in how long you have had credit. If all other things are equal, someone with good accounts for 30 years will tend to have higher scores than a person who has only had an account for a year.
4 - New credit
If you have recently taken on more debt or a new credit card, a potential lender may question if this will impact your ability to pay a home loan. New credit can lower your score for a bit, but then it usually rebounds with timely payments on the new credit.
5 - Credit mix
Think about all the different types of debt you have. If you are paying on a car, you do not want too many revolving credit accounts. But if you have a good payment history across different types of loans, it can actually help your credit score.
- Collections - These are accounts that remain unpaid for a significant period. Any account that has been sent to collections will probably impact your credit score. The more recent the collection, the more it will likely hurt your score. Every lender has specific criteria in making loan decisions. Some may want to know that you are working to clear up past debt.
- Judgments - These are collections or accounts that have won a judgment against you in court. Your score can be heavily affected by judgments. You should pay off judgments or work out a payment plan quickly.
- Bankruptcy - This affects your score both short term and long term. If you have had a bankruptcy, it is important to keep all accounts in good standing going forward. This will help your score increase over time.
- Multiple inquiries – Multiple credit inquiries can hurt your score if you are constantly getting credit checks across multiple industries. But getting your credit checked a few times by the same industry in a relatively short period of time will not lower your score. The algorithms are smart enough to recognize you may be shopping for a mortgage and don’t penalize you for that (consider it as the multiple checks being “grouped” into one).
- Multiple derogatory marks – Derogatory marks are negative items in your credit report. This could include seriously late payments, bankruptcies, legal judgments, etc. They tend to compound on each other, and the dollar amount doesn’t matter in your score. For example, your score will most likely be lower if you have 10 collections that total $500 rather than 1 collection for $5,000. The algorithm sees 10 collections versus 1 collection, not necessarily dollar amount.
Checking Your Credit Score
You can check credit scores online at the three major credit bureaus (Equifax, Experian and TransUnion). According to the Federal Trade Commission, you are entitled to one free copy of your credit report every 12 months from these three companies. https://www.ftc.gov/faq/consumer-protection/get-my-free-credit-report.
There are also various free online services, but read carefully for obligations or hidden fees. Sometimes you will get a free credit report but not a score. This is still helpful to check your credit record and clear up any disputes. Some credit card companies will show you your score every month.
What is the Minimum Credit Score for a Home Loan?
At Lincoln Lending, most programs require a minimum credit score of 580. However, we have one program that will allow a score of 530 in certain cases, and another that does not have a credit score requirement at all.
- FHA – Loans from the Federal Housing Administration (FHA) are typically good for first-time buyers. They usually require a score of 580. A score of 530 may be required under certain circumstances and if the borrower can pay at least 10% down.
- VA – Veterans Administration loans are available for veterans in good standing that meet the requirements of the program. This program require a credit score of at least 580.
- HUD-184 – Housing and Urban Development loans require a score of 184 based on specific Native American criteria. However, you can have no unpaid collections, and recent collections can be a red flag.
- Tribal - Some Native-American tribes can assist tribal members. Check with your tribe for what they may have available.
- USDA RD (Rural Development) – These loans require a 580 credit score. Your home must also be in an approved rural area. Examples include, but are not limited to, Noble, Tuttle, Newcastle, and Guthrie.
Improving a Low Credit Score
At Lincoln Lending, we can look at your credit report and see if we can help you based on your specific situation. In general, consider:
- Paying down credit cards that have a high balance compared to your credit limit.
- Establishing new, good credit. Some people - especially younger home buyers - actually don’t have enough open lines of credit. Algorithms need to see open credit in order to score you and for your score to improve. If you only have one open account, you may want to get more. But be sure to pay each one off or keep the balance low… as stated previously, 10% or less of your credit limit.
- Resolving credit bureau disputes. Go online to each bureau to review the process for disputing information on your report, then check your report for anything of which you were previously unaware. Clearing up errors can often help your score.
- Paying debts on time starting right now. Do everything in your power to make payments on time and your credit scores will start to increase.
There are a variety of loan options available for first-time home buyers… even if your credit score is not as strong as you’d like it be right now. One of the best ways to prepare for home ownership is to meet with a mortgage lender before you even start looking for a home.
The Lincoln Lending (NMLS 398026) team regularly meets with potential home buyers to review their specific situations and discuss options. While we cannot legally give financial advice, we can check your credit score and become a “coach” to help you prepare to qualify for a home loan. Just call (405) 799-5363 or email us at email@example.com to schedule a no-cost, no obligation meeting to see if the timing is right for you.