What are mortgage lenders looking for?
You have re-assessed your goals and buying a home is now at the top of your list. That’s great, but what is your current credit score and what does it need to be to qualify for a mortgage loan? Most consumers know that credit scores are critical for getting a loan, but they don’t know much about how they work or what lenders look for. In this article, I’ll explain how we get a credit score, how to track and improve your score, and what scores are necessary to qualify for a mortgage loan.
If you are like the vast majority of home buyers, you do not have enough cash to purchase a home outright and will need leverage (a mortgage loan) to complete the process. During the approval process, lenders will review your credit history, including your credit score. What exactly are they looking for?
1: Credit history (depth) and middle credit score: because mortgage loans are much larger and pose a higher risk, lenders will review ALL of your credit history and they will use your middle credit score for qualifying (as apposed to car loans or credit cards which use only one score). If you have established credit over at least the last few years, you will have one credit score from each of the three major credit reporting agencies: Equifax, Experian, and Transunion. Each agency has its own proprietary statistical model that analyzes your credit history and spits out a score. The scores range from 450-850, with the median score in the US around 710. Mortgage lenders will pull what is called a “Tri-Merge” credit report which contains all of your credit history and each of your three scores. They then use the middle score for qualifying.
2: The only government approved site to obtain and track your credit scores is annualcreditreport.com. According to federal law, we are all allowed to get a copy of our credit report every 12 months for free. This site will walk you through the process of ordering an individual report or a tri-merge report that includes your actual credit scores. I recommend using this system once per year and keep a copy of your report in your records. Please note that other “credit monitoring” services (like through your bank or credit card) offer to provide your credit score, but they are not accessing your credit history through the three bureaus so they are not providing your actual FICO scores. Since the bureaus are for-profit entities, they charge a fee for the scores, third parties offering free credit monitoring will not pay these fees, so they are simply using their own model to “estimate” your credit score. Still, these monitoring services are valuable because they will give you a good idea of where your score is (I suggest subtracting 15-20 points to get more accurate estimate) and they can signify a change in your credit. If your score through a monitoring service drops unexpectedly, you know something has happened and the sooner you fix it the better.
3: What is the required middle credit score to qualify for a mortgage loan? This depends on the type of loan, the majority of mortgage loans require credit scores of 620 or higher, with some government loans allowing for lower scores (580 or above). In most cases, lower credit scores result in a higher interest rate, higher mortgage insurance premiums, and larger down payments. What is the ideal credit score? I tell my clients to shoot for a score of 740 or higher and work to keep it there. In general, if your credit score is 740 or higher, you will qualify for the best interest rate and loan terms for mortgages, car loans/leases, credit cards, personal and business loans (not to mention home and car insurance premiums). What can you do to improve your score if it is lower or maintain your high score? Each of the three credit bureaus have tools on their web site to help consumers increase their scores. My advice: do not miss any payments, always follow up on medical bills to make sure they are paid (even if you believe insurance has handled), keep revolving credit card balances at or below 15% of the credit limit, keep business and personal credit separate, and limit the number of new credit inquiries to 1-2 per quarter.
In summary, we should all strive to have credit scores above 740. The best way to achieve this is by limiting your credit card utilization, paying all accounts on time, limiting the number of new credit inquiries, and keeping an eye out for any major changes. There are many great tools that consumers can use to get and keep an excellent score, an honest and experience mortgage broker is one of them.