Updated: Jul 14, 2020
When becoming a home buyer a mortgage loan is usually needed to be able to purchase a home. One thing that will be looked at is your credit score. The first step is to know your credit score. This can be found for free through most credit cards. You can also pull your free credit report from each of the three credit bureaus at annualcreditreport.com. This can be done for free once per year per credit bureau. The three credit bureaus in the United States are Experian, Transunion and Equifax. It is important to check your credit report to ensure everything is accurate and there are no errors.
Types of Mortgage Loans
Now that you know your credit score, you can figure out what type of loan you can quality for. It is important to remember that an optimal credit score for the best interest rates is a 760.
Conventional loans are the most common way people people get their mortgage. The minimum credit score for this mortgage loan is 620 and the minimum down payment is 3%. Private Mortgage Insurance (PMI) will also be paid as a monthly fee if less than 20% is put down. In addition to a down payment, to get a home loan you will ideally need your monthly payment to have a debt to income ratio at or below 36%. These loans can be done in fixed and adjustable rates. The benefit of a fixed loan is knowing exactly what your payment will be for the next 15 to 30 years. If interest rates go down you can always refinance to that lower rate in the future. The structure for these loans is set by Fannie Mae and Freddie Mac. These are not a government agency but are a company created by the U.S. Congress. These institutions buy and guarantee mortgages in the secondary mortgage market. This establishes a standard if lenders wish to buy and sell the mortgage note.
Fixed Rate conventional loans keep the same interest rate throughout their entire lifetime. Throughout paying off the loan, you will have the same dollar amount every month with a slightly decreased interest payment and slightly increased principle payment that will total the same amount.
Adjustable rate mortgage (ARM) will generally one of three types. These are a 5/1 ARM, 7/1 ARM, and 10/1 ARM. These loans are stating that they will have a set interest rate for the first few years (such as 5 years for a 5/1 ARM) and will then adjust on a yearly basis after. This means that with a 5/1 ARM after 5 years the lender will notify you what the new rate will be. These have a set margin such as 2.25% that will be added to whatever index-able rate the lender gets at that point in time. There are also generally a lifetime cap rate, where even if there are higher interest rates, the lender cannot increase your loan past that rate. These types of loans are great for individuals who know they won't be at the home for longer than their rate lock or if the mortgagee thinks that there will be lower interest rates in the future.
Jumbo loans are designed for luxury properties and carry a high loan amount usually $765,601 or greater. These loans are not eligible to be purchased by Fannie Mae or Freddie Mac meaning that there unique underwriting requirements and tax implications. They will also be looked at more stringently and will generally require a credit score of 700 or higher and a good debt to income ratio. These loans are also generally going to have a higher interest rate than the standard conventional loan. If you are a high income earner with a household income of $200,000-$500,000 than this type of loan could be for you.
FHA Loans are insured by the federal housing administration and is designed for low to middle class first time buyers. To qualify as a first time home buyer you cannot have owned a property within the past two years. With a credit score of 580 you can get a loan with only 3.5% down payment. You can also qualify with a 500 credit score but will need to put a 10% down payment. FHA Loans require an upfront mortgage insurance premium (UFMIP) and an additional monthly private mortgage insurance (PMI). The upfront mortgage insurance premium is equal to 1.75% of your loan value. For example, on a $300,000 loan * 1.75% = $5,250. This will be paid upfront or sometimes can be rolled into your overall loan. The PMI which is paid monthly is usually equal to 0.45%-1.05%. For example a $300,000 loan * 1.0% = annual $3,000 or $250 additional per month. This payment will continue for 11 years of the life of the loan depending on the terms. One way to avoid this long cycle of additional payments, is if your home has gone up in value. If your home does go up in value, you can refinance your home as you have gained equity and therefore your loan to value will be will be less than the new higher appraised value. This can then qualify you for a conventional loan through a multitude of lenders.
FHA Loans also have additional requirements. The loan to income ratio is your monthly loan payment including principle, interest, insurance, HOA fees and property taxes, divided by your monthly income. This ratio shows lenders how affordable this loan is for you to still have some leftover money to handle your other expenses. Ideally your loan value should be 31% or lower however you could be approved up to 40%. The back end loan to income ratio includes all of your other consumer debts such as car loans or credit card debt. Your back end loan to income ratio should be below 43% however some individuals can qualify if they are below 50%.
FHA Loans also have loan limits. This is established per county and is 115% of the median home value. To verify your county you can visit the HUD website. The chart below gives you a quick idea on what could qualify for your area.
Veterans affairs (VA) Loan
VA loan is a great option for those who have a military background. This mortgage is backed by the veterans affairs and can get a 0% down loan with no private mortgage insurance (PMI). While there is no required credit score required from the VA, many creditors want a FICO score of 660 or higher. If you fall below that, call around to multiple mortgage lenders and find one that will work with you. To qualify you must have been in active service in wartime for 90 consecutive days, active during peacetime for 181 days, 6 years of service in the national guard or be the spouse of a service member who has died in the line of duty. The loan does require an inspection of the property to ensure that it meets the high standards of habitability so don't expect to use this for a flip. The VA website provides some great up to date information about rates and more.
USDA Loans are designed for rural areas to help farmers and others move towards home ownership. This type of loan does not have a minimum credit requirement but a FICO credit score of 640 or higher is highly preferred. These loans can have a no down payment option and can will generally have a lower PMI premium than other loan types including FHA and conventional loans. These loans are designed for communities that have less than 20,000 population however you should check if your property qualifies.
How Credit Score is Calculated
If you have a bad credit score so you cannot quality for a home loan or you want to improve your credit score, this is how the FICO credit score is calculated.
35% On Time Payments
Making payments on time also known as payment history is a large portion of how a credit score is calculated. Creditors care if you have paid your bills on time when establishing your creditworthiness. One way to help this can be to turn on automatic payments to ensure that you will not miss any due dates.
30% Credit Utilization
The amount of credit that you have taken out or how much you are using on your credit cards effects your credit score. If your using all of your credit, lenders are afraid that you are overextended. To help with this you can pay off whatever is owed on your credit card balance as you use them instead of waiting for the end of the month. The other thing that can be completed is asking for a higher credit line. The credit utilization is a percentage basis so if you spend $100 with a $500 credit line you are using 20%. However if you spend $100 with a $5000 credit line you are only using 2% of your utilization.
15% Length of credit history
The length of credit history is a moderate part of how your FICO credit score is calculated. When trying to purchase a home, it is important to plan early. Since this is a smaller part of how credit is calculated, it is nothing major to be concerned about.
10% Credit Mix
Credit mix is a small part of how a credit score is calculated, this means that creditors want to see a mix of credit used. Some different types of credit is credit cards, retail accounts, installment loans and more. It is also important not to open too many accounts as new credit can also hurt your credit score.
10% New Credit
Too much new credit can adversely affect your credit score as taking too much credit out at once represents a higher risk. The timeline for "new" credit is two years.
How to Improve your Credit Score
Check your credit report for errors. These can be disputed and possibly have them overturned.
Becoming an authorized user for a family members loan or credit card can help establish additional credit history for yourself. Make sure however that this is someone trusted as if they don't pay you are responsible for the payment or could make your credit score worse.
Utilize Experian Boost, this service gives you credit for your current phone and utility bills.
Pay down your credit card to lower your credit utilization. This is 30% of your credit score and can have an immediate impact.
Time is on your side when increasing your credit, keep paying your bills on time and your credit will slowly rise.
How to get a mortgage with no credit history
FHA loans are backed by the federal housing authority and they do accept none standard forms of credit history. To qualify you will need to have to meet the following conditions:
No missed rent payments
No more than a thirty day delinquency from other payments. This includes but not limited to your electric bill, cell phone plan and more.
There are no collection accounts to your name with the exception of medical bills
Additional Mortgage Lender Considerations
Savings, is one thing that mortgage lenders look at. They want to ensure that you have ideally an additional 6 months worth of savings encase if you lose your job right after closing the home. This however can include your 401K/IRA savings. Remember you don't have to tap into it just need to show it is available.
Debt to income ratio is important to make sure that you are not house poor after closing. It is ideal to have a loan value that is equal or below 36% of your pretax income.
Employment history, is important to creditors to show that you have a stable income. They will be asking to look at your last two years of employment. Although you don't need the same job it is important to stay within the same industry.
How to Get Better Mortgage Rates
Put down a larger down payment, creditors will lower interest rates depending on how much money you put down, up to 40% of the value of the home.
Have a cosigner, especially if they have a good credit score.
Shop around to different mortgage lenders, every lender will work with you differently and sees risks differently.
Research discount points, points are a higher upfront payment to reduce your interest rate which could save you money in the long term
Research mortgage programs, there are lots of state specific programs that can help first time home buyers, public servants and more. Colorado offers down payment assistance programs through CHFA.
Questions to ask your lender
What loan types do you offer?
Are there any prepayment penalties?
How much of a loan do I qualify for?
Are there any origination or similar fees?
What is the APR of the loan?
Is there an initial PMI and/or a monthly PMI payment?
What kind of points do you offer? Can I get negative points to help cover some of the closing costs?
If you are in need of a Denver Realtor® to pursue home ownership, together we can make it happen!