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How Credit Scores Impact Loans

Mortgage lenders check your credit history before approving a home-buying loan, so your credit scores are crucial to getting the amount you want to borrow at a good interest rate.  

Your income versus your debt, your payment history, the length of time you’ve had credit, new credit you’ve opened, and the types of credit you owe (such as student loans or consumer debt) are all calculated in a valuation system known as credit or FICO scores. 

FICO scores range from 300 to 850, but because mortgage loans are so large and have such a long payback period, most lenders require scores between 520 to 700 and above, depending on the type of loan – conventional or conforming. Credit score minimums required by banks to qualify for these loans can change, depending on market conditions and the bank’s assessment of their own risk. 

Conventional loans

According to QuickenLoans.com, conventional mortgages meet the minimum criteria required by Fannie Mae and Freddie Mac, entities that purchase the loans from banks and package them into securities to be sold on the secondary, which is why your loan service can change from your original lender. When the bank is allowed to sell their loans, it can borrow more money overnight from the Federal Reserve and make new loans. Conventional loans are ideal for those with good to excellent credit; they offer competitive rates and flexible terms. However, they aren’t guaranteed by any government entity, and therefore require higher credit scores to qualify. 

If you have a score of 620 or higher, you can qualify for a conventional loan. Those with scores of 740 or higher can usually get by with a lower down payment and still are able to qualify for a low interest rate. 

Conforming loans

Conforming loans are loans that are insured by the federal government. They’re less risky for lenders than conventional loans and therefore easier for homebuyers to qualify for them both as purchase loans and when homeowners want to refinance their mortgages. 

FHA loans are insured by the Federal Housing Administration and can be obtained for as little as 3.5% down, which makes them the ideal product for borrowers with lower credit scores or for those who must spend a greater portion of their income on housing. 

The advantage of an FHA loan is that a smaller down payment allows you to get into a home of your own much faster, which is why most first-time or lower income homebuyers go FHA. In 2021, the FHA requires a minimum FICO score of 580 to qualify for a 3.5% down payment loan and a FICO score of 500 to 579 for a 10% down payment.   

There are some requirements and restrictions. FHA loans are only available for primary residences. Your debt-to-income ratio can be no larger than 43%, and you must have steady income and proof of employment. The maximum FHA loan amount is $331,760 and $765,600 for high-cost areas. In addition, non-removable mortgage insurance is required. 

U.S. Department of Veteran Affairs is the guarantor for VA loans and the eligibility requirements are far more complex. You must be a member or veteran of the U.S. Military or a member or veteran of the U.S. Military Reserves or National Guard and apply for a certificate of eligibility. Approximately 90% of VA loans are granted with no down payment required, but borrowers are required to pay an upfront funding fee of about 2.3% of your loan. 

While the VA sets no minimums on credit scores and doesn’t require private mortgage insurance, lenders require a minimum FICO score of 620. 

For any loan, the larger your down payment, the lower your credit score can be. Credit scores also impact interest rates. The better the score, the better the rate.