Is a low credit score keeping you from getting a mortgage during COVID-19?
Credit scores are a pivotal part of the home-buying process. Not only does your credit score determine if you qualify for a loan, but it also determines your mortgage terms, most importantly, your interest rate.
First-time homebuyers often jump into the process of looking to buy a home without really knowing where their credit scores stand, or what the credit score requirements are for a home loan. It turns out that last year's average FICO® Score was 706, considered to be a good score of creditworthiness. But that number includes many who already own homes and have been paying mortgages regularly for some time. A general rule of thumb is that existing homeowners have higher credit scores than renters.
The good news is you don't need a perfect credit score to get a home loan. Depending on your situation, there are a variety of loan options available, and each comes with different credit score requirements. At the start of 2020, for example, a FICO credit score of 620 was typically the benchmark needed to buy a house with a minimum down payment of 3.5%. With the changing market and rising unemployment rate due to COVID-19, those benchmarks may have changed from lender to lender. Always speak to a loan officer to determine what the credit score requirements are for the type of loan you're looking for in your location.
This article will dig into how credit scores are determined and loans that are good choices for first-time homebuyers. Towards the end, we'll provide tips on how to improve your credit score and keep it healthy.
What a credit score consists of
Why is maintaining a good credit score important? It shows the lender that you can be depended on to repay your loan on schedule. To keep on top of things, it's good to understand what goes into building a credit score. For example, a FICO credit score is:
- 35% payment history: Are you making complete payments on time?
- 30% debt-to-credit ratio: Compare how much credit you're using with how much you have available
- 15% length of credit history: Do you have ten months or ten years under your belt?
- 10% credit mix: What type of credit do you have? May include credit cards, student loans, automobile loans, and mortgages.
- 10% new credit accounts: How many times within the past 24 months have you applied for new credit?
Applicant requirements by type of loan
We're going to look at four types of common loans and discuss how to get the best terms on your mortgage.
An FHA loan is best for first-time homebuyers who don't have stellar credit or much savings to put towards a down-payment. Because the Federal Housing Administration insures these loans, applicants with lower credit scores might find FHA loans to be a good fit.
How it works:
- At Movement, applicants for FHA loans must have a credit score of 580 or higher.
- FHA loans are a go-to for first-time homebuyers, primarily because they have little saved up for a down payment and not a lot of credit history built up.
- Rules around gift money to cover down payments are relaxed. As long as you can prove that the cash is, in fact, a gift and that no repayment is expected, 100% of the down payment can come from parents, relatives or an employer.
Backed by the U.S. Dept. of Veterans Affairs, a VA loan (as in Veterans Affairs) requires little-to-no down payment and is designed for veterans or active service members buying a home. A surviving spouse of a veteran can also apply for this type of mortgage.
How it works:
- In most cases, Movement Mortgage will look for a credit score of at least 580 for VA loans.
- There's usually no down payment with a VA loan, but there is a funding fee payable at closing. Expect anywhere from 1%–3% of the total amount borrowed. This can be financed into the loan or paid out of pocket at closing.
- Private mortgage insurance (PMI) is not required, and closing costs are often much less than typical mortgages. They're even sometimes paid by the seller.
- There is also no penalty if you pay the loan back earlier than planned. Also, the Department of Veterans Affairs can help troubled borrowers with payment assistance.
USDA loans were designed for low-to-moderate-income buyers looking to purchase a home in a rural or semi-rural area. And since the U.S. Department of Agriculture backs them, a down payment may not be required for eligible applicants.
How it works:
- At Movement, applicants for USDA loans must have a minimum credit score of 580.
- Buyers can't earn more than 15% above the local median salary.
- USDA loans offer financing at 100%, often come with reduced mortgage insurance premiums, and allow the seller to contribute to the closing costs.
- The home purchased must be in a qualified “rural” area, which is typically defined as having a population of less than 20,000. To help strengthen these rural communities, the home must be used as a primary residence, not a weekend getaway.
A conventional loan is designed for first-time homebuyers looking to get a more traditional mortgage, typically backed by Fannie Mae or Freddie Mac. Because these loans are not government-backed, PMI is required, unless a 20% down payment is applied.
How it works:
- Conventional loans have stricter credit requirements than government-backed loans, so you'll need a credit score of 620 or higher.
- Financing can be as high as 97% of a home's price, with down payments as low as 3%.
- Great for buyers with good credit and a stable job but with little saved for a down payment.
- While the government loans above can have certain property restrictions, a conventional loan can be used for nearly all property types.
6 tips to keep your credit score looking good
If your credit score isn't as high as you'd like, there are simple ways you can work on building it. These tips can help first-time homebuyers improve their credit scores:
- Make payments on time: This one may seem obvious, but it's one of the biggest factors that affect your credit score. Even if you only owe $5 on a retailer credit card, you'll get dinged if you miss a payment.
- Put off new credit applications: Lots of credit cards lure in new accounts by offering rewards offers, cash-back programs and sign-up bonuses. Too many of these and lenders will think you're too reliant on credit and a risky borrower.
- Pay off credit card balances if possible: This tip impacts your debt-to-credit ratio. If you're applying for a mortgage, keep credit card balances low. Don't wait till the end of the month to pay off your cards, pay them off every week if you can, at least until you're in the clear. Doing so could be the difference in a good interest rate and one that should have been better.
- Be error-free: Get a free credit report and scan it for errors like incorrect name or address, unrecognizable credit lines, duplicate entries and other errors. Dispute any that you find.
- Keep revolving credit accounts open: Wait until after your mortgage goes through to closing credit card accounts, even if they're not used. Keeping them open shows you have available credit, but you're not tapping into it. It improves your debt-to-credit ratio.
- Fix your credit mix: Many people have just one credit card, especially if it's one that gives you frequent flier miles on a favorite airline or cash-back on everything you buy. But having just one card limits the number of monthly payments you can make. Opening another card allows you to prove you're more reliable when it comes to making timely payments. Just don't do it too close to your mortgage application. Plan to get a few months of steady payments under your belt.
Talk to a local loan officer or apply online
If you're a prospective first-time homebuyer, and your credit score is in good standing, reach out to one of our local loan officers to discuss which mortgage would be best for you. Or if you're ready to get started, apply online today!