From Credit to Keys: How Your Credit Score Impacts Your Mortgage

A mortgage is a type of loan used to buy or refinance a home. Unlike personal loans or credit cards, mortgages are secured by the property itself. Mortgages come in various forms, including conventional, FHA and VA loans, each with distinct requirements. Mortgage lenders look at many factors before offering a loan — your income, debt, employment and, importantly, your credit score.

This guide focuses on your credit score and its role in obtaining a mortgage. In addition to exploring the impact of your credit score on your mortgage, we also share practical steps you can take to improve your credit and chances of approval.

Your credit score, a three-digit number between 300 and 850, is a snapshot of your credit history. It’s like a financial report card that reflects your borrowing behavior.

Generally, scores above 670 are considered good, while those below 580 are seen as poor. FICO and VantageScore are the two credit-scoring models used. The average FICO credit score in the U.S. has remained steady at 716.

While FICO and VantageScore may differ slightly in their criteria, they have the same objective: to help lenders assess the risk involved in lending you money. A high score indicates you've managed your debt well in the past and are likely to repay future debts, resulting in favorable loan terms. A high credit score can unlock lower interest rates, reducing the overall cost of your mortgage. It can also affect the loan amount your lender offers and the requirements for your down payment.

In contrast, a lower credit score may limit your borrowing capacity or necessitate a larger down payment to counteract the lender's perceived risk. If you have a lower credit score, you might have to pay for private mortgage insurance (PMI), adding to your monthly payments. Even with a great credit score, paying less than 20% down may still entail PMI costs, but having a higher score can lead to lower PMI expenses.

Not all mortgage loans weigh credit scores equally. Conventional loans, which are not insured by the federal government, tend to have stricter credit score requirements. A lower score might result in significantly higher interest rates, or you might not be approved at all.

On the other hand, government-backed loans, such as FHA loans, VA loans and USDA loans, are often more forgiving when it comes to credit scores. These programs are designed to help more people become homeowners, making them more lenient with credit score requirements. However, even with these programs, a higher credit score typically results in more favorable loan terms.

Understanding the credit score requirements for different types of mortgages can help you evaluate your financing options more comprehensively and allow you to find the type that best aligns with your credit profile and homeownership goals.

When it comes to securing a mortgage, a low credit score can shape your mortgage experience in numerous ways, including:

• Higher Interest Rates and Costs: A low credit score often leads to higher mortgage interest rates, resulting in higher monthly payments and a larger total loan cost. Lenders charge more to compensate for the perceived risk of lending to borrowers with a spotty credit history.
• Difficulty in Mortgage Approval: Being green-lighted for a mortgage can be an uphill battle with a low credit score. Lenders may refrain from lending to individuals with poor credit, fearing missed payments or defaults.
• Limited Loan Options: Borrowers with low credit scores may find their loan options limited to certain types of mortgages, such as FHA or other government-backed loans. Conventional loan products might be out of reach until they can improve their scores.

Having a low credit score doesn't mean you can't own a home. However, it does mean that the process of navigating your mortgage might be a bit more complicated.

Improving your score before seeking a mortgage can help simplify the process: below, MoneyGeek explores proven tactics through specific scenarios to help you enhance your credit score before applying for a mortgage. For those unable to improve their scores before seeking a mortgage, we also examined practical strategies for securing a mortgage.

Time is often of the essence; sometimes, you don't have the luxury of waiting to build up your credit score before buying a home. In this situation, there are routes to homeownership available, including:

• Government Assistance Programs: Instead of minimum credit score requirements, some programs — like VA loans — primarily consider factors like income, employment history and the size of the loan you're seeking.

• Subprime Lenders: While these lenders may be more willing to work with low credit scores, they often charge higher interest rates. Borrowers should be cautious, as the risk of falling into a cycle of debt is significantly higher.

• Co-Signing Applications: Co-signers with good credit can help you secure loans and rates you might be unable to otherwise. However, they will also shoulder the responsibility for the loan if you default.

Navigating the intersection of credit scores and mortgages can be a challenge. We’ve included commonly-asked questions about the topic to help you navigate it.