For many, buying a home is still considered an important part of the American Dream. Even following the real estate crash, many still want to purchase homes. The idea of “owning” a residence still exerts a strong pull for many.
However, few people actually have the resources to pay for a house with cash. Most homebuyers have to borrow in order to get enough money to buy a home. This type of loan is called a mortgage.
Since lenders are putting up the money for a house in these situations, it isn’t surprising that many of them prefer not to risk a default. As a result, lenders rely heavily on credit scores to determine who gets in the door for a loan.
On top of that, lenders also use credit scores to set interest rates. You are charged for borrowing money, and how much you pay in fees depends on how risky you appear; your credit score is a measure of that risk — a higher credit score means less risk.
What is the Minimum Credit Score to Buy a Home?
Like so many things in the realm of personal finance, the credit score you need to buy a home depends on your individual circumstance. The type of loan you get, and where you get it, matters.
Here are some of the scenarios you can expect to run into if you want to buy a house:
- Conventional Loan: This is a loan from “regular” lenders. If you go to your local bank, and you aren’t getting a government loan, or a loan from an entity like Fannie Mae, you will need a credit score of at least 650 to even be considered for a mortgage.
- Fannie Mae: This company specializes in encouraging homeownership. And, because many expect the government to bail out Fannie Mae if there are problems, the lender is willing to take on more risk than more conventional lending institution. As a result, you can usually get a loan from Fannie Mae if you have a credit score of at least 620.
- FHA Loan: Following the mortgage market crisis, the Federal Housing Administration upped its minimum credit score for a loan. However, the credit score is still fairly low, at 580. Additionally, you need only a 3.5% down payment to qualify for a FHA loan.
It’s worth noting, too, that a VA loan doesn’t list a minimum credit score. A qualified veteras can therefore apply for a loan — and stand a good chance of getting it — no matter his or her credit score.
Your Credit Score and Your Interest Rate
Even though you have good enough credit score to get financing for a loan, it doesn’t mean that you are going to get the best deal. Realize that if you just meet the minimum requirement to qualify for financing, you will probably have to pay a higher interest.
The truth is that the minimum credit score required to qualify for mortgage financing isn’t even considered “good.” In the case of a Fannie Mae or FHA loan, the minimum score is actually in “poor” territory. That means that lenders consider you a higher threat of default. In order to protect themselves, lenders will charge you a higher interest rate for your mortgage.
You might pay more than 2% higher if you have a score at the low end of the “acceptable” range. Over time, this can make a big difference in your final payment amount.
If you just figure principal and interest on a 30-year fixed rate home loan of $200,000, the interest rate can make a huge difference:
- Excellent credit (above 740), 3.35% rate: $317,212.74 total
- Poor credit (minimum required score), 5.50% rate: $408,808.08 total
As you can see, the difference between having excellent credit and just meeting the minimum is almost $100,000 over the course of 30 years. What would you do with that extra money? How could you put it to use if you weren’t paying it in interest?
If you plan to buy a house soon, it makes sense to consider taking steps to improve your credit score. While you might be able to get a mortgage, even with poor credit, you’ll want to boost your score so that you aren’t stuck paying as much in interest.
Photo credit: foilman.
Miranda is a professional personal finance journalist. She is a contributor for several personal finance web sites. Her work has been mentioned in and linked to from, USA Today, The Huffington Post, The San Francisco Chronicle, The New York Times, The Wall Street Journal, and other publications. She also has her own personal finance blog: Planting Money Seeds.