The dream of owning a home is a cherished goal for many individuals and families. However, the path to homeownership is often paved with financial hurdles, and one of the most significant factors influencing your ability to secure a residential mortgage is your credit score. In this comprehensive guide, we will explore the the intricacies of credit scores and their role in obtaining a residential mortgage, providing you with the knowledge you need to open the door to your dream home.

What Is a Credit Score?

A credit score is a numerical representation of your creditworthiness, indicating how likely you are to repay borrowed money. This three-digit number, typically ranging from 300 to 850, is used by lenders to assess the risk of extending credit to you. The higher your credit score, the more favorable loan terms and interest rates you are likely to receive.

Components of a Credit Score

Credit scores are calculated based on several factors, with the two primary credit scoring models being FICO and VantageScore. While the exact formulas are proprietary, we do know the general factors that influence your credit score:

1. Payment History: This is the most critical factor, comprising about 35% of your credit score. It reflects whether you’ve paid your bills on time, had late payments, or defaulted on any loans.
2. Credit Utilization:** This accounts for roughly 30% of your score and measures the amount of credit you’re using compared to your total available credit limit. Keeping your credit utilization low is crucial for a high score.
3. Length of Credit History: The length of your credit history makes up about 15% of your score. Longer histories tend to be more favorable, as they provide a more comprehensive picture of your borrowing habits.
4. Credit Mix: This considers the types of credit accounts you have, such as credit cards, installment loans, and mortgages. A diverse mix can positively impact your score.
5. New Credit Inquiries: When you apply for new credit, it can lead to hard inquiries on your credit report, which may temporarily lower your score. New credit inquiries make up about 10% of your score.
6. Public Records and Collections: Bankruptcies, tax liens, and collections can severely impact your credit score. These events typically stay on your credit report for several years. While certain unpaid medical debt in collections can negatively impact your credit score, starting March 31, 2023, the credit reporting agencies will no longer include medical collections under $500 on your credit report—so those accounts won’t hurt your credit.

The Role of Credit Scores in Mortgage Approval

When you apply for a residential mortgage, your lender will pull your credit report and assess your credit score. Your credit score plays a pivotal role in determining whether you’ll be approved for a mortgage and the terms you’ll receive, including the interest rate and down payment requirements.

Credit Score Thresholds

Mortgage lenders often categorize borrowers into different tiers based on their credit scores. These categories can vary slightly between lenders, but a common breakdown might look like this:

1. Excellent Credit (740 and above): Borrowers in this range typically qualify for the best mortgage rates and terms.
2. Good Credit (680-739): While not as favorable as excellent credit, borrowers in this range still have access to competitive mortgage options.
3. Fair Credit (620-679): Borrowers with fair credit may face slightly higher interest rates and may need to meet additional criteria.
4. Poor Credit (Below 620): Securing a mortgage with poor credit can be challenging, and borrowers may need to explore specialized loan programs or work on improving their credit.

Keep in mind that Lakeside Bank has several programs where the negative impact of a lower credit score is ignored depending on the borrower’s income, the location of the property and if the borrower is a first time homebuyer. Make sure that you contact your Lakeside Bank mortgage loan consultant to get more information.

Impact of Credit Scores on Mortgage Terms

Your credit score directly affects the cost of your mortgage. A lower credit score can result in:

1. Higher Interest Rates: Borrowers with lower credit scores are considered higher-risk, so lenders compensate by charging higher interest rates. Even a fraction of a percentage point can significantly impact your long-term mortgage costs.
2. Larger Down Payments: Some lenders may require larger down payments for borrowers with lower credit scores. This increases the upfront cost of homeownership.
3. Private Mortgage Insurance (PMI): If your credit score is below a certain threshold (often around 20% down payment), you may be required to pay for PMI, which protects the lender in case of default.
4. Limited Loan Options: Borrowers with low credit scores may be limited to certain mortgage programs, such as FHA loans, which are specifically designed for individuals with lower credit scores but come with their own set of requirements and costs.

Your Lakeside Bank mortgage loan consultant has several programs where the negative impact of a lower credit score is ignored depending on the borrower’s income, the location of the property and if the borrower is a first time homebuyer. Also, Lakeside’s portfolio loan product has the same rate and down payment regardless of credit score as long as you otherwise qualify.

Strategies to Improve Your Credit Score

If your credit score is currently preventing you from qualifying for a residential mortgage or getting favorable terms, don’t despair. There are several steps you can take to improve your credit score. It makes sense to work with our Lakeside Bank mortgage loan consultant to find ways to improve your credit score.

1. Have your Credit Score Pulled: Borrowers try to avoid having a hard pull on their credit score to limit credit inquiries. If you do not see your credit score until right before buying the home, there is little time to fix it. Have your credit pulled early in the process to address any issues.
2. Review Your Credit Report: Obtain a copy of your credit report from all three major credit bureaus (Equifax, Experian, and TransUnion) and review it for errors or inaccuracies. You can fix any discrepancies you find.
3. Pay Your Bills on Time: Consistently paying your bills on time is one of the most effective ways to boost your credit score. Set up reminders or automatic payments to ensure you never miss a due date.
4. Reduce Credit Card Balances: High credit card balances relative to your credit limits can harm your score. Aim to reduce your credit card balances to below 30% of your credit limits. Work with your Lakeside mortgage loan consultant to determine which credit card balances should be paid down first.
5. Avoid Opening New Credit Accounts: Each new credit inquiry can temporarily lower your score. Be cautious about opening new credit accounts, especially in the months leading up to a mortgage application.
6. Establish a Long Credit History: While you can’t change the length of your credit history overnight, maintaining older accounts in good standing can positively impact your score over time. If you have family members with long credit histories, you can leverage their good credit to improve your own.
7. Seek Professional Help: If your credit issues are complex, consider working with a credit counselor who can provide personalized guidance. Be very careful who you pick to help raise your credit. Ask you Lakeside Bank mortgage loan consultant for a referral to a credible credit repair professional.

Mortgage Options for Different Credit Profiles

Even if your credit score is not in the “excellent” range, there are mortgage options available to you. Lenders have developed various programs to accommodate borrowers with different credit profiles:

1. Conventional Loans: Your standard Fannie Mae and Freddie Mac conventional loans allow for credit scores as low as 620, particularly if you have a strong down payment. Conventional loans typically have the lowest private mortgage insurance (“PMI”), you want to check there first.
2. FHA Loans: These government-backed loans are accessible to borrowers with lower credit scores (typically a minimum of 580) and require a lower down payment (as low as 3.5%). You want to compare the interest rate and PMI of FHA loans to get the best deal.
3. VA Loans: If you’re a qualifying veteran or active-duty service member, VA loans offer competitive terms, including no down payment and more lenient credit score requirements.
4. Portfolio Loans: Some smaller lenders or credit unions offer portfolio loans that don’t adhere to conventional underwriting standards. These lenders may be more willing to work with borrowers with lower credit scores. Lakeside Bank has a portfolio loan that has the same rate regardless of credit score and is great for people with new credit.
5. Homebuyer Assistance Programs: Many states and local governments offer homebuyer assistance programs that provide down payment assistance and other financial incentives to low and moderate-income homebuyers. These programs sometimes have higher credit score and lower debt requirements. They also may have income limits and restrict your sale of the property. Make sure you read the fine print!

The Road to Homeownership

Owning a home is a significant milestone in life, and understanding the role of credit scores in securing a residential mortgage is a crucial step on this journey. While credit scores are essential, they are just one piece of the homeownership puzzle. Factors such as your income, debt-to-income ratio, and employment history also play a significant role. Speak with our Lakeside Bank mortgage loan consultant about how to manager your credit and what mortgage options best fit you.