If you’re in the market for a home loan, you will want to take a look at your credit score first, before starting the homebuying process. Since the housing mortgage crisis of 2008, practices have become much stricter when determining who qualifies for a loan, the amount they are willing to loan, and at what percentage rate.
Your credit score has a major influence in determining what kind of home loan you can qualify for. Essentially, the higher the score the better; but there are home loan types that take other factors into consideration, such as, employment history, income, and debt to income ratio. Other lenders will offer loans to consumers with lower credit scores, assuming a large down payment accompanies the loan.
Why Credit Matters
Home loans are incredibly common. Even though almost half of the U.S. population has a fair credit ranking or lower, most of us still own homes — about 60% of households in fact. The terms of the loan vary largely based on your credit score. So the best credit score will save you thousands of dollars in interests and fees.
Home lenders look at your home loan as a product that they can sell off to other mortgage carriers. So they need to make sure their products are enticing to potential buyers. A mortgage granted to a consumer who is less than reliable with their payments makes for a far less attractive product to other mortgage carriers than a home loan granted to a consumer who has impeccable credit.
To do business with buyers with a less than stellar credit profile, different types of mortgages have become popular. These alternative loans tend to have built-in guarantees backed by federal programs and often require little or no money down. Traditional loans, however, are still the most prevalent and are granted based on a combination of credit rating, employment stability, and income.
Types of Home Loans
Traditional home loans tend to be fixed-rate 30-year loans. A fixed-rate mortgage features an interest rate that remains the same for the entire lifespan of the mortgage. While adjustable-rate mortgages were more popular ten years ago, since the mortgage bust, the fixed-rate mortgage has become the first loan of choice once again. Adjustable-rate mortgages feature a fixed rate for a short period of time, then switch to a variable rate that climbs higher every year.
For individuals recovering from poor credit, FHA loans are available. Buyers with a minimum of a 500 credit rating can apply for an FHA loan. An FHA loan is insured by the Federal Housing Administration in an effort to keep the house purchasing market robust. To help mitigate the lower credit score, buyers usually are required to place a larger down payment or suffer a higher interest rate.
FHA loans are a great choice for first time home buyers who may not have much of a credit history established yet, resulting in a lower credit score. Buyers who are able to only put 3.5% of the sales price down, must at least have a credit score of 580. But, if a buyer can put down 10% they can qualify with a lower credit rating, between 500 and 579. Besides looking at credit, buyers need to have two years of established employment with the same employer.
VA Loans are home loans guaranteed by the U.S. Department of Veterans Affairs (VA). They are dedicated loans for U.S. military veterans, active-duty military, reservists, and some other select qualifying individuals. VA loans are financed through approved lenders and allow borrowers to finance 100% of their loans with no down payment.
Credit scores don’t come into consideration with VA loans as they do with other loans since any qualifying veteran can obtain a VA loan. The VA will guarantee up to 25% of a home loan up to $113, 275. VA loans were started in 1944 through the Servicemen’s Readjustment Act, aka, the GI Bill of Rights in an effort to provide housing stability and homeownership for the welfare of veterans and their families. The VA loan is still widely popular today thanks to its 25% guarantee and availability to qualifying veterans.
USDA Home Loan
Another popular federally backed loan is the one offered through the U.S. Department of Agriculture to eligible rural and suburban homebuyers. The program known as the USDA Rural Development Guaranteed Housing Loan Program aims to help rural and suburban families by offering low-interest rates and no down payments.
USDA loans are granted in two ways: either directly through the USDA to very low-income buyers at interest rates as low as 1%, or through qualifying lenders at a low-interest rate and no money down conditional upon the payment of a mortgage insurance premium.
The intention behind federally backed loans like the USDA, FHA, and VA is to keep the housing market robust and accessible to buyers of all income levels and financial background. Not everyone qualifies for these types of loans, however. So the best thing you can do to ensure you get the best loan terms is by monitoring your credit in the expectation that you’ll be applying for a traditional loan.
Improving Your Credit
Before applying for a home loan, the first thing you need to do is look at your credit report to see where you stand. Identify your weaknesses, and create a plan for improvement. The most important areas to focus on are the debt to credit ratio (30% of your score), and payment history (payment timeliness – 35% of your score).
The easiest way to raise your credit score is by paying off debt. If you’re looking to apply for a home loan, it may be worth waiting until you can pay off a good portion of the debt, since a higher credit score will save you a great deal of money in interest over the life of a 30-year loan. The other way is to make sure all of your payments are made on time, every time, no matter what kind of credit line you’re paying on. Lenders update payment history regularly, so staying on top of payments is crucial.