How Does My Credit Score Affect My Mortgage Loan?

Everybody has a checklist in mind when they start shopping for a house. You probably are thinking hard about size, location and cost – but have you given a lot of thought yet to your credit score?

With interest rates rising, banks are tightening their wallets, so it’s more important than ever to understand exactly what a credit score is and what it means to your future. Unless you have enough money socked away to pay cash for a home, your credit score can be the number one factor that decides whether or not you can afford to buy. 

What’s a Credit Score?

Your credit report and your credit score are not the same things – but they are deeply connected. The information in your credit report is ultimately what’s used to calculate your credit score, and a better credit history equals a higher credit score, expressed in a three-digit number.

While there are different types of credit scores, the most widely used model is generated by the Fair Isaac Corporation and is called a “FICO” score. These scores were the first to create an industry-wide standard that allowed banks to evaluate the risks of lending a particular consumer money. 

FICO scores range from 300 (or very poor) to 850 (which is perfect). As of 2022, the average FICO score was 716 – a figure that’s stayed remarkably steady since early 2021. 

Generally, the following data factors into what kind of score you receive:

• Your payment history: On-time payments to your credit cards and loans raise your score, while late payments and missed payments lower it.
• The amount of credit you’re using: Credit utilization is calculated by the percentage of your available credit that you’re currently using. Using too much signals the bank that you might be overextended – while using too little can make a bank nervous that you will do so in the future.
• The length of your credit history: If you haven’t had credit very long, that doesn’t give a bank much to examine, so a longer credit history is better than a short one.
• The type of credit you have: While this only slightly affects your score, a mix of revolving credit and installment loans shows that you’re not relying on one source of credit to the exclusion of all others.
• The number of credit inquiries: Any “hard” credit check can damage your credit a little because that indicates that you’re looking to take on new debt. That’s why you don’t want to allow these until you’re really ready to get serious about a loan.

Other credit scoring companies, like VantageScores, tend to operate with similar models and provide similar scores. Due to slight differences in the way they treat the data from your credit history, however, your credit score can change from model to model. (Keep that in mind when you’re researching loans and ask the bank what credit scoring system they use.)

What Effect Does a Good or Bad Credit Score Have on a Loan?

Your credit score is a tool that lenders use to assess the risk that you’ll someday default on your loan. If you have a high credit score, you will be deemed more “creditworthy” than someone with a low credit score. 

In other words, along with your debt-to-income ratio and work history, your credit score may very well control whether you even qualify for a loan from a particular lender. It will also most definitely control whether you get the lowest interest rate that a bank is able to offer – or one that’s considerably higher.

When you’re taking on a mortgage, you want the lowest possible interest rate you can get from a lender because that represents both monthly savings (in the form of a lower mortgage payment) and savings over the life of the loan (in total interest paid). In short: A good credit score can save you hundreds a month and tens of thousands over the life of your loan, while a poor credit score can cost you just as much.

What Kind of Credit Score Do You Need to Get a House Loan?

Conventional banks generally want to see a credit score that’s 620 or higher, although some have more stringent criteria. VA loans also require a credit score of 620 or higher, while FHA loans can be obtained with a score as low as 500. Those with low scores may also need a cosigner for a bigger down payment to get a loan.

All that being said, it’s wise to know that your credit scores change all the time, and you can take control of the situation before you ever apply for a loan. With an eye to the future, you should:

1. Enroll in an online service and get your credit score from at least one of the three major credit reporting agencies (Experian, Equifax and TransUnion).
2. Get a free annual credit report from all three of those agencies and review them for missing information and mistakes. If you find any, file a dispute with the agency to get the issue corrected.
3. Pay down your credit card balances to improve your credit utilization percentage. Aim to use no more than 30% of your available credit at any given time. Do not close any accounts you pay off, since that could increase your credit utilization ratio.
4. Don’t allow anyone to run your credit needlessly. For example, don’t allow a clerk to talk you into applying for a store card to get a discount price on something you’re buying. When they check your credit, that counts as a “hard” pull and lowers your score.

Finally, pay all of your bills on time. Even if you have had problems in the past with your payment history, a year or two of good credit habits can bring dramatic changes to your credit score.