Your credit score, the number that lenders use to estimate the risk of extending you credit or lending you money, is a key factor in determining whether you will be approved for a mortgage. The score isn’t a fixed number but fluctuates periodically in response to changes in your credit activity (for example, if you open a new credit card account). What number is good enough, and how do scores influence the interest rate you are offered? Read on to find out.
The most common credit score is the FICO score, which was created by Fair Isaac Corporation. It is calculated using the following different bits of data from your credit report: your payment history (which represents 35% of the score), the amounts you owe (30%), length of your credit history (15%), types of credit you use (10%) and new credit (10%).
There is no “official” minimum credit score since lenders can (and do) take other factors into consideration when determining if you qualify for a mortgage. You can be approved for a mortgage with a lower credit score if, for example, you have a solid down payment or your debt load is otherwise low. Since many lenders view your credit score as just one piece of the puzzle, a low score won’t necessarily prevent you from getting a mortgage.
Since there are various credit scores (each based on a different scoring system) available to lenders, make sure you know which score your lender is using so you can compare apples to apples. A score of 850 is the highest FICO score you could get, for example, but that number wouldn’t be quite as impressive on the TransRisk Score (developed by TransUnion, one of the big three credit reporting agencies), which goes all the way up to 900. Each lender also has its own strategy, so while one lender may approve your mortgage, another may not – even when both are using the same credit score.
While there are no industry-wide standards for credit scores, the following scale from personal finance education website www.credit.org serves as a starting point for FICO scores and what each range means for getting a mortgage:
• 740 – 850: Excellent credit – easy credit approvals and the best interest rates.
• 680 – 740: Good credit – borrowers are typically approved and offered good interest rates.
• 620 – 680: Acceptable credit – borrowers are typically approved at higher interest rates.
• 550 – 620: Subprime credit – possible to get a mortgage, but not guaranteed. Terms will probably be unfavorable.
• 300 – 550: Poor credit – little to no chance of getting a mortgage. Borrowers will have to take steps to improve credit score before being approved.
The Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development, offers loans that are backed by the government. In general, the credit requirements for FHA loans tend to be more relaxed than those for conventional loans. To qualify for a low down payment mortgage (currently 3.5%), you’ll need a minimum FICO score of 580. If your credit score falls below that, you can still get a mortgage, but you’ll have to put down at least 10%, which is still less than you would need for a conventional loan.
While there’s no specific formula, your credit score affects the interest rate you pay on your mortgage. In general, the higher your credit score, the lower your interest rate, and vice versa. This can have a huge impact on both your monthly payment and the amount of interest you pay over the life of the loan. Here’s an example: Let's say you get a 30-year fixed rate mortgage for $200,000. If you have a high FICO credit score – for example, 760 – you might get an interest rate of 3.612%. At that rate, your monthly payment would be $910.64, and you’d end up paying $127,830 in interest over the 30 years.
Take the same loan, but now you have a lower credit score – say, 635. Your interest rate jumps to 5.201%, which might not sound like a big difference – until you crunch the numbers. Now, your monthly payment is $1,098.35 ($187.71 more each month), and your total interest for the loan is $195,406, or $67,576 more than the loan with the higher credit score.
It’s always a good idea to improve your credit score before applying for a mortgage, so you get the best terms possible. Of course, it doesn’t always work out that way, but if you have the time to do things like check your credit report (and fix any mistakes) and pay down debt before applying for a mortgage, it will likely pay off in the long run. See What Are the Best Ways to Rebuild My Credit Score Quickly and Best Ways to Repair Your Credit Score.
Even though there is no “official” minimum credit score, it will be easier to obtain a mortgage if your score is higher – and the terms will likely be better, too. Because most people have a score from each of the big three credit agencies – Equifax, Experian, and TransUnion – lenders often pull a “tri-merge” credit report that contains scores from all three agencies. If all three credit scores are usable, the middle score is what’s called the “representative” score, or the one that’s used. If only two scores are usable, the lower one is used.
You can get preliminary information on where you stand for free: Each year, you are entitled to one free credit report from each of the big three credit agencies. Getting a free credit score is more difficult, but an increasing number of banks and credit card companies are making these available, as are some websites (see Getting Your Credit Score from a Bank and Websites That Offer a 'True' Free Credit Score).
For more on this topic, see Credit Scores and Your Mortgage Payment: It Matters.