According to data from the Origination Insight Report by Ellie Mae, the average FICO® score on closed loans was 753 in February 2021. (FYI, a “perfect” credit score is 850). As lending standards have tightened recently, many are concerned over whether or not their credit score is strong enough to qualify for a mortgage. Stricter lending standards could be a challenge for some. However, many buyers may be surprised by the options that are still available for borrowers with lower credit scores. Though conventional and jumbo loans demand higher credit scores – with an average minimum credit score around 620 – government-backed mortgages accept lower scores. Below we answer the age-old question: what credit score do you need for a mortgage? The answer to what the minimum credit score for buyers is might surprise you.
What Credit Score Does the Average Home Buyer Have?
The average American has seen their credit score go up in recent years, which is a great sign of financial health. In 2020, the average American’s credit score was 703. At the same time, 59% of American adults had a score over 700 points. As someone’s score rises, they’re building toward a stronger financial future. Because there are more Americans with strong credit in the housing market, an increase in the FICO® score distribution of closed loans occurs. This is shown in the graph above.
If your credit score is below 750, it’s easy to see this data and worry you will not qualify for a mortgage. That’s not always the case. The minimum credit score required by lenders is higher than you think. The majority (over 50%) of borrowers right now do have a score above 750 points. However, there’s more to qualifying for a mortgage than just the credit score. Furthermore, the average credit score of a home buyer in 2020 was actually quite a bit lower than 750 points. According to Paris Ward in an article for Intuit brand Credit Karma was much lower. Ward writes that “the average VantageScore 3.0® credit score across…for those who opened a mortgage tradeline in the past two years is 717.” Buyers in California averaged 730 while those in New Hampshire topped the list with an average 739 credit score. Massachusetts buyers were not far behind, averaging a 738 score. Of course, a higher credit score should get you a better interest rate on your mortgage. However, a lower credit score does not necessarily mean you are unable to borrow. There are quite a few options that allow people with lower credit scores to buy their dream home.
Which Credit Report Do Mortgage Lenders Use?
Before underwriting a loan, mortgage lenders check each prospective borrower’s credit score to ensure it is above the minimum credit score required. However, the score mortgage lenders use could be quite a bit different than the score you expect to see on your application. In her article “This is the credit score lenders use when you apply for a mortgage” for CNBC, Megan DeMatteo elaborates. She notes which credit score lenders use and explains how they calculate that score.
DeMatteo notes that most lenders use your FICO Score or VantageScore credit report when deciding whether to offer you a loan. This score is calculated by the Fair Isaac Corporation. According to DeMatteo, the score mortgage lenders use could be different from the one you see when monitoring your credit. This is because “banks use a slightly different credit scoring model when evaluating mortgage applicants.”
FICO Models Used for Mortgage Lending
Lenders usually use the FICO® 8 model for credit checks for car loans and credit cards. Instead, mortgage lenders use the FICO® Score 2, FICO® Score 5 and FICO® Score 4 models. These are from the three credit bureaus: Experian, Equifax and TransUnion respectively. While borrowers applying for mortgages are “still evaluated on the same core factors…the categories are weighed a little bit differently.” Instead of focusing on “high balances on revolving credit lines” like the FICO® 8 model, other models “put less emphasis on credit utilization ratio.”
Other parts of your credit history like your payment history are typically weighed more heavily during the mortgage application process. Generally, how lenders define creditworthiness varies depending on the market (e.g. credit cards, mortgage loans, car loans, etc.). If all three credit report scores are different, lenders will choose the median score. Conversely, if two are the same, they will choose the credit report score that repeats. Buyers who apply for a mortgage jointly with a partner end up with a loan based on the lower score from their credit reports.
The Cost of a Lower Credit Score
When you accept a mortgage loan offer with a lower credit score, you not only pay higher interest rates and mortgage payments. You might also pay higher premiums elsewhere. In her article “5 Types of Private Mortgage Insurance (PMI)” for Investopedia, Amy Fontinelle explains. Fontinelle writes that “the riskier you look…the higher your premiums will be.” The general rule is that “the lower your credit score and the lower your down payment, the higher your premiums will be.” Of course, homebuyers who put down a traditional 20% down payment might not pay higher premiums. This is because they have demonstrated that they are not as high-risk.
Those who put down less than 20% pay a higher monthly payment on their private mortgage insurance premium. The lower the buyer’s credit score and down payment amount are, the more they pay. You can find a mortgage insurance rate card here from The Mortgage Reports which can help you estimate your PMI. Keep in mind that mortgage insurance is usually more expensive with some government backed loans than with conventional or jumbo loans.
How Much Could I Save With A Better Credit Score?
Borrowers with higher credit scores typically save on interest with a lower fixed rate on their mortgage. In an article for The Ascent, Maurie Backman explains how much you could save over time with a higher credit score. Backman writes that “generally speaking, you’ll need a minimum FICO® Score of 620 to qualify for a mortgage.” However, lower credit scores come with higher interest rates. In order to qualify for the best rates and save on interest over time, buyers need “a score in the mid-700s or higher.” The savings are real and can be quite dramatic. In 2021, home buyers with a score between 760 and 850 can expect a 2.441% interest rate. Those with a score between 620 and 639 can expect a 4.030% interest rate.
If you apply for a mortgage loan with a “760 credit score as opposed to a 620, you might pay $87 less per month.” Given most mortgages are paid over thirty years, during this time that $87 per month would add up to “a savings of $31,320.” We are at a somewhat unique time in history for borrowers with less than ideal credit, however. Thankfully, the “4.030% rate you might get today even with a relatively low credit score actually isn’t bad” compared to the past. As such, it could still be worth it to take out a mortgage at this rate.
Can I Still Save On Interest With a Lower Credit Score?
Thankfully, those with lower credit scores are not necessarily stuck with high interest rates. Buyers with lower credit scores can pay discount points at closing to reduce their mortgage interest rate if they have the money on hand. If you are a prospective first time home buyer, chances are you have not heard of discount or mortgage points. In their article “What Are Mortgage Points and How Do They Work?” for Next Advisor by TIME, Jason Stauffer and Kathryn Pomroy explain. Stauffer and Pomroy write that “purchasing mortgage points…is a strategy that involves paying additional money upfront at closing.” In doing so, homeowners can “shave down the interest rate of [their] loan.”
Lenders sometimes refer to purchasing points as “buying down the rate” because that is exactly what borrowers are doing. Buyers are buying down the rate of their interest payments from their mortgage lenders. Purchasing points is typically only recommended for home buyers who “plan to stay in their home for several years, usually at least six.” This is because “it typically takes a borrower between 4-6 years to recoup the cost from paying discount points at closing.” If you plan to sell in the near future, it might be better to stick with a higher interest rate and invest elsewhere. Those who do choose to purchase points usually buy anywhere from fractions of a point to three points in total. A single point is equivalent to 1% of your loan.
Alternatives to Purchasing Discount Points
With the burden of other closing costs, mortgage points are not affordable nor worthwhile for all buyers. There are a couple other ways to save on interest other than buying points. Making a larger down payment when you buy a house can also result in lower interest payments throughout the life of your loan. You can also shop around, comparing loan offers from multiple lenders until you find the best deal. Refinancing your mortgage in the future is another way to save.
Minimum Credit Score Requirements for Conventional and Government Backed Loans
Here is a brief overview of what Experian, one of the major credit reporting agencies, says:
Federal Housing Administration (FHA) Loans
According to Experian, “with a 3.5% down payment, homebuyers may be able to get an FHA loan with a 580 credit score or higher.” Experian writer Ben Luthi notes that “if you can manage a 10% down payment, though, that minimum goes as low as 500.”
The U.S. Department of Housing and Urban Development often recommends these government insured loans for first time home buyers. This is because first time home buyers rarely have much cash on hand for a hefty down payment. For those unfamiliar with FHA loans, Zach Wichter explains in his article “FHA loans: Everything you need to know in 2021” for Bankrate. Wichter writes that an “FHA loan is a government-backed mortgage insured by the Federal Housing Administration.”
These types of loans are attractive to many buyers – particularly first time buyers. This is because they “require lower minimum credit scores and down payments than many conventional loans.” Last year, the FHA reported that “more than 83 percent of all FHA loan originations were for borrowers purchasing their first homes.” Though FHA loans are insured by the government, “they are actually offered by mortgage lenders that have received the FHA’s stamp of approval.”
Requirements for an FHA Loan
Home buyers can opt for either a 15 or 30-year fixed rate mortgage with an FHA loan. In order to qualify, Wichter writes that buyers must “have verifiable employment history for the last two years” and current verifiable income. They must also live in the house that qualifies for the mortgage and file it as a primary residence. Their debt ratio must be no higher than 31% of their monthly income before their mortgage is considered. Learn more about the requirements for an FHA loan here. Unfortunately, those who opt for an FHA loan when they buy a house “must pay FHA mortgage insurance,” which can be expensive.
US Department of Agriculture or USDA Loans
According to Experian, the credit score needed for a USDA loan is a minimum 640. However, “some may go as low as 580.”
In his article “What Is a USDA Loan?” for Experian, Jim Akin elaborates on what home buyers need to get this type mortgage. Akin writes that USDA loans are “single-family home loans designed to help buyers with lower-than-average incomes and less-than-ideal credit.” USDA loans are also designed to boost sales of homes “with values considerably lower than those in their local markets.”
Offered by the USDA’s Rural Development Guaranteed Housing Loan, USDA loans are usually available to buyers of homes in rural or suburban areas. According to Akin, homes in “densely populated areas” do not qualify for USDA loans as this is not the purpose of the program. Like other government backed loans, USDA loans only apply to homes that are filed as primary residences. There are three primary types of USDA loans, including Section 502 Direct Loans, Single Family Housing Repair Loans and USDA Guaranteed Loans.
Department of Veterans Affairs or VA Loans
The credit score needed to buy a home with a VA loan is actually undefined. According to Experian’s Ben Luthi, “VA loans don’t technically have a minimum credit score, but lenders will typically require between 580 and 620.”
If you or a spouse are a veteran, you could qualify for a VA loan insured by the U.S. Department of Veterans Affairs. Julia Kagan explains the requirements and benefits of VA loans in an article for Investopedia. Kagan writes that “veterans, service members, and their surviving spouses” may qualify for a VA loan. Those who do “can purchase homes with little to no down payment and no private mortgage insurance and generally get a competitive interest rate.” VA loans can also be used to finance home improvements and major repairs as well as in refinancing.
According to Kagan, mortgage loans backed by the US Department of Veterans Affairs do not mandate any down payment or private mortgage insurance. Upon closing, all closing costs can be paid by the seller and the amount of these costs is heavily regulated. Perhaps best of all, the Department offers borrowers additional financial assistance to help them avoid default. Additionally, those who pay their loan off early will not face a “prepayment penalty.” There are also no credit score requirements aside from endorsement as a “satisfactory credit risk by a lender.”
In “What Is a Conventional Loan?” for Experian, Ben Luthi writes that this “loan type typically comes with a 620 minimum credit score.” Conventional mortgage loans also require a debt-to-income ratio under 50%.
Unlike FHA loans, conventional loans are not backed by the federal government. They not only have stricter credit score requirements but also more restrictive down payment requirements. A conventional loan is usually a conforming loan. Conforming mortgages meet all requirements necessary in order to be sold to the Federal National Mortgage Association. Sometimes, a conventional loan might be non-conforming and not in line with FNMA requirements. Jumbo loans are one example of non-conforming conventional mortgages.
A higher credit score will give you more options and better terms when applying for a mortgage. (A score of 800+ is considered “exceptional,” and 850 is considered “perfect.”) But don’t rule yourself out if your score is less than perfect – today’s market is still full of opportunity.
When planning to buy a home, speaking to an expert about steps you can take to improve your credit score is essential. Here are some pre-mortgage tips from our mortgage lenders. Don’t let assumptions about whether your credit score is strong enough put a premature end to your homeownership goals!