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Preparing to Buy a Home? Start by Settling Your Credit Score.
When you decide to buy a home, every bit of preparation pays off. It’s a complicated and time-intensive process, and diving in blind can lead to some disastrous outcomes.
The first step is to make sure your credit score is up to snuff. Let’s explore why your credit score is so important, and how you can make sure it’s high enough to purchase a home.
How does my credit score impact my ability to buy a home?
When it comes to applying for a mortgage, lenders look at two things: your income and credit score. And while most borrowers know their income, few know their real credit score and understand how it could affect a future mortgage.
Your credit score is the first hurdle to qualifying for a mortgage. The exact credit score you need depends on the type of mortgage you’re applying for. To qualify for a conventional loan, the most common type of mortgage, you’ll need to have a credit score of 620 or higher.
FHA loans have lower credit score requirements. You only need a 500 credit score to be eligible for an FHA loan, but you’ll have to make a 10% down payment if your score is between 500 and 579. If your score is above 580, you’ll only have to make a 3.5% down payment.
USDA loans usually require a credit score of 640 or higher, while VA loans usually have a 620 minimum credit score.
How Credit Scores Affect Mortgage Insurance
Insurance companies use your credit score as a sign of responsibility. The more responsible you are as a borrower, the more likely you are to be a responsible homeowner.
When you apply for a mortgage, you usually have to make a down payment that acts as collateral for the lender. If you put down less than 20% on a conventional mortgage, you’ll have to pay Private Mortgage Insurance (PMI).
PMI is a monthly fee that covers mortgage insurance, which protects the lender in case you default. PMI costs can range between 0.25% to 2% of the loan balance.
Your credit score is partially used to determine how much the lender charges you for PMI. The higher the credit score, the lower your PMI costs. Your credit score may also affect how much you pay in homeowners insurance premiums.
How to Find Your Credit Score
Some borrowers will look up their credit score before buying a mortgage to ensure it meets the basic requirements. However, the score they see often isn’t the one that lenders use.
Most borrowers use free sites to find their credit score, but these sites usually show the VantageScore credit score. Unfortunately, 90% of lenders – including most mortgage lenders – use a FICO credit score. FICO and VantageScore use mostly the same criteria to determine your credit score, but the exact scoring algorithms may be different.
If your credit score is on the cusp of qualifying for a mortgage, you might want to wait a few months for it to increase. That’s because any time you apply for a mortgage or other type of loan, the lender will run a credit check.
This will result in a hard inquiry on your credit report, which could ding your credit score about five to 10 points. If you had a 620 credit score, a 10-point drop could knock you out of the running for a conventional mortgage. It takes a year for hard inquiries to fall off a credit report.
How does my credit score affect loan costs?
Qualifying for a mortgage is one thing – qualifying for the lowest interest rates is another. Lenders offer a range of interest rates, and you need an excellent credit score – usually 740 or higher – to receive the best rates.
Having a high credit score helps you get a lower rate for any kind of loan, but it’s even more important for a large loan like a mortgage. Because a mortgage is likely the biggest loan you’ll ever have, even a slight change in interest rates can yield a huge difference.
Here’s how your credit score could impact loan costs. Let’s say you want to buy a $200,000 home with a 30-year term and a 20% down payment. You have a 650 credit score and you qualify for a 3.5% interest rate. Over the life of the loan, you’ll pay $98,779.65 in total interest costs.
But if you had a 700 credit score and qualified for a 2.75% interest rate, you would only pay $75,183.68 in total interest over the life of the loan. If you had an 800 credit score, you could qualify for a 2.5% interest rate and only pay $67,623.53 in total interest.
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