Mortgage lenders look at many factors when determining your loan eligibility and rate, including your credit score. You may understand the importance of having a good credit score, but just how important is credit score when buying a home? Here are some of the factors lenders are taking into consideration when you apply for a mortgage.
What is credit score?
Your credit score is a significant indication of your financial responsibility—the higher your score, the more appealing you are to lenders. A credit score is based on data from the three major credit bureaus, Experian, Equifax, and TransUnion. The most common credit model is from the Fair Isaac Corporation (FICO). Using the FICO measurement system, scores at or above 800 are considered excellent, while scores under 580 are poor. When your credit score is in a healthy range, you’re more likely to be approved for a loan and offered a lower interest rate. You’ll also be able to take advantage of certain programs not available to those with lower scores. For borrowers on the lower end of the spectrum, you may have to pay a higher rate or be subject to private mortgage insurance (PMI) since you have a higher risk factor.
Other significant factors
Credit score is very important when applying for a loan, but it’s not the sole factor lenders consider when you’re trying to buy a home. Your debt-to-income ratio (DTI) is another. DTI is a proportion of how much money you have left over after you’ve paid your monthly bills. If your DTI is 36% or less, it is generally considered favorable. However, if your debts are more than your income, you will look less attractive to lenders. An acceptable DTI can range depending on the lender. Note that DTI measures your income before taxes and other deductions.
During the loan process, you’ll need to give your lender several important documents, including your bank statements and a valuation of your assets. This includes cash, vehicles, stocks, and bank accounts. When you have assets of value, it makes you seem less risky as a borrower. Having an accessible source of funds shows that you have a safety net if your income decreases, so you could still make a mortgage payment if necessary. Bank statements are needed to see if you overdraw your account frequently and to ensure your money is coming from legitimate sources.
Down Payment Amount
A down payment is the money you pay upfront when you buy your home, while the rest of the home’s price will be paid off during the life of the mortgage. The amount you’re able to put up for the payment affects your loan-to-value ratio, or LTV. The more money you’re able to put toward the down payment, the lower your LTV will be. While the amount needed for a down payment depends on the home price and what loan program you use, it’s advisable to have an LTV no higher than 80% if you’re seeking a conventional loan. Having a lower LTV can make you look appealing because it reduces the loan amount, meaning lower risk to the lender.
Income and Employment
Income is an essential component when applying for a loan because it means you’re employed and making money. Lenders aren’t just concerned about how much you’re earning; they also consider how long you’ve held your current position and job. Your lender will need at least 2 years of employment documentation to determine how stable you are. Income isn’t limited to what you make from work—it can also include payments for alimony, child support, or disability.
When it comes to buying a home, mortgage lenders look at the whole financial picture, not just your credit. Your credit score is certainly influential when buying a home, and you should continuously be making efforts to improve it. It’s wise to aim to be financially healthy all around to make the loan process smoother. Even if your credit isn’t in prime condition, you can still look into loan programs with more flexible credit requirements, such as an FHA or USDA loan. Don’t be afraid to have a conversation with your lender about realistic expectations and how you can make yourself more stable.
If you have any questions or want more information about loan programs, contact one of our Licensed Mortgage Loan Originators. If you are ready to begin the homebuying process, click here to get started!