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Getting Approved for a Mortgage: The Role of Your Credit History

Getting approved for a mortgage involves proving to lenders that you’re willing to repay your home loan as agreed, and that you’re capable of doing so. Your ability to repay is determined by your income, but many borrowers who can afford to pay their bills don’t actually do so. This is why mortgage lenders look at credit scores when deciding if they will lend you money. According to the Federal Reserve, credit scores are very good at predicting who will pay back a loan as agreed and who will default.

Here are some things you need to know about the role of your credit history in getting approved for a mortgage.

How Does Your Payment History Affect Your Credit Score?

FICO scores are calculated from information that is reported by your creditors. (FICO is the company that owns the most commonly used credit scoring systems in the U.S.) This data is incorporated into your file, and your score is calculated by FICO’s proprietary systems. Each category of information is weighted according to its importance:

  • Payment history: 35 percent
  • Amounts owed: 30 percent
  • Length of credit history: 15 percent
  • Credit mix: 10 percent
  • Amount of new credit: 10 percent

Payment history is the most important determinant of your credit score, so be sure to always pay your accounts within 30 days of the due date to keep your history perfect. You’ll also want to avoid letting accounts go into collections, which is considered a highly derogatory event.

How Costly Are Blemishes?

What happens if, despite your best efforts, you miss a payment? That depends on what your score was before. For example, if your current score is 680, a payment classified as late by 30 days drops your score by 60-80 points. That is a very big deal because most nongovernment mortgage products set their minimum FICO scores at 620. If your current score is 780, you’re likely to lose 90-110 points. Getting approved for a mortgage remains likely, but you’ll pay more for it. Fortunately, the effect of a mishap diminishes over time, and your score can eventually bounce back.

What Credit Score Is Needed for a Mortgage?

Even though Fannie Mae and Freddie Mac, the two corporations that set mortgage guidelines for the majority of conventional mortgages in the U.S., set their minimums at 620, most lenders who sell loans to them have higher thresholds. Mortgage software firm Ellie Mae reports mortgage data every month, and in October 2015, it indicated the average FICO score for approved loans was 722, and the average score for denied loans was 650. According to FICO, the average score in the U.S. today is 695. Only very strong applicants, with sizable down payments and excellent incomes, are likely to be approved with a low credit score.

However, those who borrow government-backed loans, such as one by the Federal Housing Administration (FHA) or United States Department of Agriculture (USDA), can be approved with a lower FICO score. But these loans do have higher costs upfront and higher monthly mortgage insurance premiums. Private insurers also charge higher rates to those with lower scores.

How Does Your Credit Score Affect the Price of Your Mortgage?

Conventional mortgages (by Fannie Mae and Freddie Mac) are priced in 20-point tiers based on the buyer’s FICO score. For example, a loan for 85 percent of the purchase price to someone with a 660-679 FICO score costs a full percentage point more than one to an applicant with a 780-799 score. For a $200,000 mortgage, that one point difference may cost you $2,000. This makes it very important to avoid using credit, applying for new credit or missing any payments in the months before you apply for a mortgage.

When Do Lenders Run a Report?

Lenders need your Social Security number and your permission to pull your credit report. When you authorize them to check your credit, they’ll usually order a “tri-merge” report. This combines information from the three largest credit bureaus: Experian, Equifax and TransUnion. Your lender notes all three bureaus’ scores and uses the middle of the three. If you apply with a co-borrower (for example a spouse), the lender determines both of your middle scores, then uses the lower one for underwriting and pricing.

If you’re considering buying a home, it pays to take care of your credit history. When a lender runs your credit report, it will determine whether you’re qualified for a loan, and it will affect the price of your loan. So whether you’re buying now, or considering buying in the future, be sure to be aware of how your credit history can affect your mortgage.

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