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You’re interested in buying a home and know your credit score can impact your ability to get a mortgage. But do you know why it has such a major impact on whether you’ll get approved for a home loan?
Mortgage lenders need to know that giving you a loan is a good investment where they can make money rather than risk losing it.
Your credit score summarizes the complex factors of your financial situation into a standard number that you and a lender can use to understand your likeliness to qualify for a mortgage you can afford.
We’ve provided insight into how a lender considers your credit score and how it potentially impacts the terms of a mortgage.
Why is your credit score so important to lenders?
Lenders consider your FICO scores to understand if you can afford a mortgage. FICO scores are the credit scores most lenders use to determine your credit risk and the interest rate you will be charged. You have three credit scores from each of the three different credit bureaus, Experian, TransUnion, and Equifax.
When assessing whether you qualify for a mortgage, your credit score is a major factor because it summarizes your financial situation for a lender, including the following factors, in order of their impact on your score:
- Payment history
- Credit card usage
- Credit age
- Total accounts
- New accounts
- Hard inquiries
Beyond these factors, any derogatory marks, missed payments, or bankruptcies are red flags to lenders.
With this picture of your financial standing, a lender can more easily determine whether you’ll responsibly pay them back for a mortgage they lend you.
The higher your score, the less you can expect to pay for your loan, as this can reduce your interest rate. For example, a score of 760, compared to 620, can mean the difference of tens of thousands of dollars over the lifetime of your loan. If your score is too low however, you may not get approved for a large enough loan to afford the home you want.
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Proof of stable income and employment
A lender needs to see that someone interested in buying a home has stable, predictable income to afford monthly mortgage payments.
They will often request proof of income and employment, such as your pay stubs for at least the past month.
To verify this information, the proof of employment a lender will request can be quite extensive. It can include employment history for the past two years, contact information for former companies, an explanation of any employment gaps, and proof of employment from your current employer, confirming your hire date and employment status.
A balance of assets and liabilities
A lender needs to see how your income and expenses flow to understand if you manage your finances responsibility and have stable income. They’ll likely request to see bank statements for the past month to two months.
It’s important to show proof of your assets, such as statements for checking and savings accounts, investment and retirement accounts, stocks, bonds, and other securities. If you own a home or another property, or owned real estate in the past, a lender will also request to see proof of ownership or sale.
High-value assets can show lenders that you’re less of a risk, because you’re more likely to pay your mortgage on time, even if your income changes unexpectedly.
Beyond your assets, a lender will also want to understand your existing debts, or liabilities. This could include proof of what you owe in credit card debt, auto loans, student loans, another mortgage, or any other debts.
How a lender can help you understand specific credit goals
If you’re unsure if your credit score is high enough to qualify for the mortgage you need, you can reach out to a loan officer for guidance on reaching your credit goals to purchase a home.
They can discuss the specific qualifications you should meet to afford the home you want, such as your debt-to-income ratio and down payment amount.
Reaching the right DTI ratio
Speaking to a loan officer can help you determine the debt-to-income (DTI) ratio* you need to meet and how to reach it. Your DTI ratio is the equation that compares how much you earn to how much you owe each month, which lenders use to assess their risk.
A DTI ratio of under 50% is commonly accepted. If it’s lower, a lender may approve you for a higher loan amount. If it’s higher, a lender may not approve the amount you need for a loan.
To improve your DTI ratio, determine what debts you can pay down and if you can earn more income.
* Debt-To-Income (DTI) ratio is monthly debt/expenses divided by gross monthly income
Providing the right down payment
When you’re ready to purchase a home, you’ll need to provide a down payment. This shows the lender you have a financial stake in the property.
A down payment can range from as low as 3% to as high as 20% of the cost of a home. For a home costing $200,000, the down payment could be between $6,000 to $40,000.
Paying more up front lowers the overall balance of your mortgage and shows the lender you’re less of a financial risk. However, if you’re unable to afford a large down payment, you may take on higher monthly mortgage payments that will include costs such as mortgage insurance premiums to safeguard the lender from a risky investment.
Gain a better understanding of what you can do to improve and maintain your credit here.
Learn how your credit could affect your mortgage
home.com by Homefinity can help you understand how your current credit score affects your eligibility for a mortgage.
Reach out to us to connect with a loan officer and discuss your specific situation, needs, and questions to help you get your credit score on the right track to get an affordable mortgage.
Photo by Avery Evans on Unsplash
