Note: We may earn money or products from the companies mentioned in this post.
A simple enough question, right? Yet, the answer to that question won’t truly address the question behind the question the requestor wants to know. Many people have asked me this question, and my standard answer might surprise you. Or maybe you have been researching, and none of this will surprise you. But I bet you’ll learn at least one tidbit from this article. The reply can differ based on which lenders you are asking and to which programs you apply. Many variables will play a part in the answer. For example, are you a first-time home buyer, are you buying an investment property, or do you have excellent credit or not so much? So far, I have not answered your question – and the question remains, what is the credit score needed to buy a house?
First, would it surprise you that your credit score is not the number one reason why traditional banks and mortgage companies will deny you a home loan? Yes, half the people I’ve spoken to list their credit score as the number one thing they think banks use when determining if a borrower will be able to pay them back on their loan. And, let’s face it, that is a huge concern for banks. Getting paid back is very important to them. Go figure. So, can you guess their number one criteria for deciding whether to grant a borrower this considerable loan amount?
It is simply someone’s DTI or Debt to Income Ratio. According to a NerdWallet report, “An unfavorable debt-to-income ratio (DTI) was responsible for 32% of all denials” and was the number 1 reason. Low credit score followed that up as the number 2 reason, responsible for 26% of all denials. That makes sense now. A bank’s number one focus is on getting paid back, and if you have an unhealthy DTI ratio, banks consider you at a higher risk of not paying back your loan. Now that’s not to say you will get denied, but you may have to mitigate their risk by paying more for the loan, for example, putting down a larger down payment and paying a higher interest rate overall. This example shows that borrowers with low debt-to-income ratios and higher credit scores will get more favorable terms from their lenders. So, therefore the question, “what is the credit score needed to buy a house” is one portion of the whole picture, which is an excellent reason for cleaning up your credit and paying down old and existing debt; more favorable terms equal less expensive borrowing.
When applying for a loan to buy a house, lenders will look hard at your monthly debts to calculate your debt-to-income ratio. Lenders divide the recurring monthly debt by the monthly gross income to determine the DTI ratio. Most lenders prefer a debt-to-income lower than 36%, with no more than 28% of that debt going towards servicing your mortgage. If your numbers exceed those, it may be challenging to qualify for a mortgage.
Can anything be done to help improve my DTI? Yes, but be realistic; if your ratio is way off, it could take time and dedicated work to get it back into more reasonable numbers. Some things you can do that work, but you may have to postpone that house buying experience a little, are; Start increasing the amount you pay toward your high balances on a consistent and monthly basis. When you get extra money, don’t spend it on frivolous items that will fade away tomorrow. Always put your money toward what will improve your financial standing in the long run. The big one here is debt reduction or elimination.
Well, if you’re doing some debt reduction work, this next one goes right along. Resist the temptation to take on additional debt. Instead, get another source of income by either getting a part-time job, a higher paying full-time job/promotion if possible, or start a side gig, like joining a solid Affiliate Marketing community like Wealthy Affiliate, to bring in extra cash. You’d be surprised at how fast the extra money will add up and bring down your debt. Your credit cards, if the credit card companies see you progressing with paying off large balances, they may increase your credit line or available credit, which helps lower your score (by raising your available credit). All you have to do is ask; most will allow you to request it right from your account dashboard w/o speaking to anyone. Another area of concern may not even be your fault. Review your credit report; you get a free report once a year. Review it for items that might be errors; you’d be surprised at how often wrong information gets reported to the reporting agencies. You can follow up with them and have errors removed or cleaned up.
Now, let’s go back to the question that started all this, the Credit Score. For reference, Credit Scores run in a range between 300 to 850. There is a consensus among most U.S. banks and traditional mortgage lenders on the question of what credit scores they will lend to, but that’s not the whole story. The various lenders are all in control of what they will accept, and multiple types of mortgages also have some sway. In addition, such mortgage instruments backed by federal programs have stringent requirements and guidelines. So let’s look at some of the options out there and some credit score guidelines.
– Conventional Mortgage Loans – Some banks prefer to hedge their bets and take the safe path when approving mortgage loans. Some may only consider a very good or an exceptional FICO® Score☉. In that case, they may only deal with borrowers with credit scores above 740. However, some banks deal with subprime mortgages, and these loans created for borrowers with lower credit scores are additional options. Generally, the consensus across the industry is that you can obtain a conventional loan with a minimum credit score of 620.
– FHA Loans – FHA loans are mortgages backed by the government and insured by the Federal Housing Administration. They are a good option for borrowers with credit scores less than 620. There are some levels to consider with FHA loans, and as I said before if your DTI is too high and your credit score is too low, you may be approved but at a more expensive rate. For example, with lower credit scores, you can be approved for an FHA mortgage with a score as low as 500. What will that cost? To qualify with scores between 500 and 579 will require the borrower to make a down payment of at least 10%. However, if you have a 580 or higher, you can qualify for a down payment with as little as 3.5%. Another benefit is that FHA loans are a little more forgiving of the DTI. But don’t let that stop you from working on lowering your debt and raising your income.
– VA Loans – If you are a qualifying service member, veteran, or surviving spouse of a veteran, you can purchase a home with little or no money for a down payment. The U.S. Department of Veterans Affairs doesn’t require private mortgage insurance an added savings. VA loans typically will look for a credit score of at least 620, but that is up to the discretion of the issuing agency.
– Non-Traditional – These are just some of the more traditional bank requirements; however, many other options are available. Such as private money lenders and individual investors who fix up and sell those houses and might be open to seller financing. There are always options out there. Of course, it’s always to your advantage to work on bringing your debt under control and eliminating and raising your credit score as high as possible before heading out for a mortgage; that should make sense. As we illustrated earlier, the higher your score, the better your terms will be.
Income: This is the second part of the equation in your Debt-to-Income Ratio. When a lender looks at your income, what will they see? Do you make enough to afford your future mortgage payments each month? Is your income steady? Have you had your current job for two years or more? Do you have any other sources of income that you can use, a part-time job, an income-producing hobby, or a web-based income stream? Again, the bank will consider all income streams and factor them into the equation.
Employment: You should establish your ability to keep and maintain an income-producing job. Suppose you have had the same position or been in the same industry for two years or more, which shows stability. That translates to, for the most part, you are less likely to lose your job. The longer you’ve worked in one place or industry, the stronger your case.
There are other options out there too numerous to mention in this article, and if you find yourself impacted by these issues we’ve just explored, don’t despair. First of all, there are remedies if you have been continually told ‘No’ by traditional lenders in the past.
Number 1, Get back in touch with the lender who denied you and ask them where you fell short, and if it’s a short list of fixable items – fix them and then reapply.
Number 2, Try a different mortgage lender; although they all play by similar rules, some lenders might look at certain things a little differently and be less stringent with items that lender one didn’t like.
Number 3, if you’re trying to get a conventional loan and failing to succeed, it might be wise to try a different product and approach. Try applying with a lender that offers an FHA loan program, for example. This may be what gets you over the hump.
Number 4, And if all else fails, work with a private lender to see what options might be available to you. You may need to take a more unconventional approach to home ownership, but it might just pay off in the long run. A lot of private lenders don’t do owner-occupied home lending, unless they are licensed for it.
Note: Your answer is clear if you’re an Investors who is having similar issues with DTI and lower Credit Scores. Private lenders are more flexible and they understand that investors take profits and reinvest them right away in a new project to avoid being taxed to death. If a bank pulls your bank statements, they may not like what they see. Speak with a Certified Private Money Lender who does asset-based lending and doesn’t consider your scores when deciding to approve a loan.
*Alternate Funding Solutions is a Private Money Lender offering creative financing solutions for real people looking to get on the road to home ownership and for real estate investors needing investment capital through Private Money Loans.
** Alternate Funding Solutions and any of its affiliates and/or employees are not registered investment advisors and, as such, do not hold themselves out to be. Accordingly, Alternate Funding Solutions does not render financial or investment advice. If you are seeking financial or investment advice, please consult a competent financial or investment advisor.
