Welcome to the 2018 home-buying market. Rising demand and an extremely tight supply of homes, especially in the critical starter-home market, make it difficult to realize your goal of home ownership.
In this buyer's market, you'll need two important things to land your dream home – more money and a higher credit score.
Data from the Joint Center for Housing Studies (JCHS) at Harvard University highlight the credit score issue. According to the 2017 JCHS study, "The State of the Nation's Housing – 2017," the median credit score for successful mortgage loan applications increased from a FICO score of 700 in 2005 to 732 in 2016. Lenders are still conservative in their risk assessments – aided in part by regulations put in place during the housing crisis.
In the pre-crisis market of 2005, around 10% of conventional first lien mortgages went to borrowers with a credit score below 620. That number fell to nearly zero by 2009, and as of 2016, it was still at 0.1%. Just over 3% of 2016 loans were issued within the 620-659 credit score range, while approximately 67% were issued to borrowers with credit scores of 740 or higher.
Along with your debt-to-income (DTI) ratio, your credit score is one of the most important metrics that lenders use to evaluate your ability to repay a mortgage loan. A good credit score can help you overcome a poor DTI.
According to the Wall Street Journal, Inside Mortgage Finance reports that in the fourth quarter of 2017, approximately 78% of loans with DTI ratios above 45% went to borrowers with credit scores of 700 or greater. A DTI of 45% is generally considered the upper limit for issuing conventional loans, but mortgage backer Fannie Mae changed the limit to 50% last year as long as other criteria are met. MoneyTips is happy to help you get free mortgage quotes from top lenders.
What can you do if your credit score isn't sufficient? You can consider a Federal Housing Administration (FHA) loan that allows lower credit scores and a down payment of as low as 3.5%. If you qualify, the FHA will back your loan – reducing your risk to lenders.
Generally, the minimum FICO score for an FHA loan is 580, although it's possible to go as low as 500 with extenuating circumstances. Some lenders will require a higher credit score in the 620-640 range to accept an FHA loan. For those who qualify, Veteran's Administration (VA) loans are a similar alternative.
Your other option is to work on improving your credit score and building up a larger down payment over time. Control spending in a way that allows you to pay down your debts, make sure that you pay all your bills on time, and keep your credit card spending below 20% of your credit limit if possible. You'll eventually meet your loan qualification target.
It's not just about baseline qualification, but also about the quality of the loan offers. Jordan Goodman, the personal finance expert and author known as "America's Money Answers Man," advises, "Sometimes it makes sense to wait to get your credit score up to a higher level to be able to get a lower interest rate ... when you are getting a mortgage, it's a long-term commitment." A fraction of a percentage point can mean thousands of dollars of interest savings over the life of a thirty-year loan.
In a buyer's market, it's all relative. You may have a suitable credit score to secure your preferred home – but are you competing with somebody who has an even better credit score?
You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.