What to Know About Credit When Getting a Mortgage
Since credit management isn’t taught in some schools, many adults don't have basic credit knowledge. According to the American Consumer Credit Counseling (ACCC), “more than half of Americans are unaware that credit scores measure the risk of not repaying a loan on time, rather than their ability to pay based on their annual salary.”
Understanding how credit works is important because good credit is one of the first steps to qualifying for a mortgage loan. Mortgage lenders (and other creditors) determine eligibility based on your income and credit history. So if you’re thinking about a home purchase in the future, here are three important things to know about credit when getting a mortgage.
1. Credit makes you a good (or bad) candidate for a loan
When you apply for a mortgage loan, one of the first things a lender will do is pull your credit history. Underwriters can learn a lot from the information in your credit file. This includes your credit score, your payment habits and the amount you owe on credit cards and other loans.
Credit history is critical to the approval process because many mortgage programs have a minimum credit score requirement. Conventional loans require a minimum credit score of 620 and FHA home loans typically require a minimum credit score between 500 and 580.
The amounts you owe other creditors is also need-to-know information because the lender determines affordability based on your income and current debt obligations. The less debt you owe and the higher your credit score, the easier it is to secure a mortgage.
2. You Have More Than One Credit Score
Keep in mind that you have more than one credit score. There are three credit reporting agencies—Experian, Equifax and TransUnion. Each credit bureau has its own system for calculating credit scores, so your credit score may vary slightly from bureau to bureau. When applying for a mortgage loan, your lender may pull all three of your credit reports and scores, and then use the mid-score to decide your interest rate.
3. Bad Credit is Fixable
Bad credit often results from paying bills late, or not paying bills at all. These actions lower your credit score and make it harder to qualify for a mortgage. But it is possible to fix bad credit and eventually qualify for a home loan.
Going forward, pay bills on time and develop a plan to pay off debt. Your payment history and amounts owed make up 35% and 30% of your credit score. Disputing errors on your credit report can also increase your personal score. As you improve your credit habits, your chances of qualifying for a mortgage also increase. That being the case, some people are eligible for a mortgage two years after a bankruptcy, and three years after a foreclosure.
Bad credit can prevent a mortgage approval. But if you commit to improving your credit history and credit score, homeownership can become a reality.