Buying a home is a significant investment. In 2023, the average homebuyer will spend $2,340 per month on their mortgage payments. Home prices have nearly doubled over the past few years, leaving new home buyers on the hook for a bigger chunk of debt.
This radical change also means that lenders are re-examining their standards when determining creditworthiness. Does this mean buyers need a better credit score to buy a home in 2023?
Let’s take a look.
How do Mortgage Lenders Use Credit Scores?
First-Time Homebuyer Loans (FHA)
US Department of Agriculture (USDA) Loans
Department of Veterans Affairs Loans (VA)
What is a Good Credit Score to Buy a Home in 2023
How to Increase Your Chances of Approval
The Bottom Line on Your Credit Score and Buying a Home in 2023
A credit score is a numerical system that assigns a value based on an individual’s ability to repay a debt. This score is universally understood in the finance world, providing mortgage lenders with an easy and convenient way to decide who qualifies for a loan.
An individual’s credit score is determined by factors like:
● Debt-to-Income Ratio
● Mix of Credit
● Number of Accounts
● Balances on Accounts
● Age of Accounts
● Payment History
● Credit Inquiries
Individual credit scores are assigned a numerical value on a scale between 300 (low) and 850 (excellent). While there is a range, labeling a particular score as ‘good’ or ‘bad’ is subjective.
Each lender has a unique business strategy. Some lenders will routinely offer mortgages to buyers with lower credit scores, while others draw a hard line in the sand at a certain number.
Your credit score is actually only one piece of the puzzle.
Lenders look at the whole picture:
● Credit Score: Your past performance as an indicator of future ability to pay.
● Debt-to-Income Ratio: Another measurement of your ability to pay a debt.
● Down Payment: How much cash you have to put towards the sale.
● Work History: An indicator of your ability to produce income.
Credit Score Requirements Vary by Loan Type
So, what type of credit score do you really need to qualify for a home loan? The answer depends on what type of mortgage you’re applying for. It’s also important to note that higher credit scores are typically associated with better interest rates.
A conventional loan is a traditional mortgage. Buyers do not need to meet special program requirements in order to obtain a conventional loan. The minimum credit score for a conventional loan is typically 620.
First-time homebuyer loans are a special program backed by the Federal Housing Administration (FHA), available to new homebuyers who have not owned a home in the past 36 months. These loans are secured using private mortgage insurance, which allows the lender to extend credit to some less creditworthy buyers. The minimum credit score for an FHA loan with a 3.5% down payment is 580 and with a 10% down payment is 500.
US Department of Agriculture loans are provided through a government-backed program that does not specify a minimum credit score. This leaves the decision of creditworthiness up to the lender. Most US banks use a minimum credit score of 640 as a baseline. However, since the USDA program does not specify a minimum credit score, banks are free to consider other factors like a large down payment.
These loans are designed to help US military veterans secure housing. The program does not specify a minimum credit score, again leaving the decision of creditworthiness up to the lender. VA loan programs have the most variation between lenders. Conservative lenders use the baseline credit score of 640, while other lenders will approve loans for scores as low as 580.
The threshold for a ‘good’ credit score remains consistent in 2023, with most lenders drawing the line between 620 and 630. However, home prices and interest rates are both high, meaning that it will take a lot more than a good credit score to secure that loan.
Traditionally, most lenders have used 620 as the defining line between good and poor credit. There is a slight trend towards inching that number up to 630 as lenders dole out bigger sums attached to more risk in a fluctuating housing market.
If you’re hoping to buy a new home but worried that your credit score wouldn’t be enough to get you qualified for a new mortgage, there are several things that you can do to increase your chance of approval.
Shop Conservatively Within Your Means
Just because you can get a home for $400k doesn’t mean that you should spend it at the top of your budget. Every financial situation is unique. However, many lenders will appreciate thriftiness. A lower credit score paired with a higher down payment can be a good strategy for getting a yes.
When determining how much home you can afford, first consider your current income. Then, take a hard look at your debts. Make sure you factor in student loan payments, credit card balances, car loans, and other unsecured debt to get a clear picture of what’s left–and potentially available to cover a mortgage payment.
Increase Your Down Payment to Get To have a Smaller Loan
Most mortgage programs strongly encourage–if not require, borrowers to put cash down at closing. For conventional loans, the standard is 20% of the purchase price. However, when the average home value is $376,100, that can be a tough pill to swallow.
That’s why many borrowers try to snag an FHA loan with a lower down payment requirement. In fact, most FHA borrowers can get approved with just 3.5% down. Still, increasing that number, even by 1%, can help borrowers with lower credit scores get approved for their dream homes in 2023.
Tip: To increase your chances of getting approved for a mortgage, here are 25 ways to improve your debt-to-income ratio.
Truthfully, your credit score is a reflection of financial trends over time. This means that it can be difficult to make a big difference in a short amount of time. But there are a few things you can do.
Tip: You can get a free credit report annually here.
Keep in mind there are no hacks or shortcuts to boost your credit score. Mortgage companies use this metric because it is a carefully tuned, reliable way to predict an individual’s financial health. By looking at a combination of spending habits, income potential, and personal financial behaviors, lenders can get a clear picture of the risk level associated with each borrower.
The same rules of creditworthiness apply in 2023. A minimum credit score of 620 is considered sufficient to buy a home, but that’s just one factor in the approval process. You’ll also need to be able to afford a home, and with housing prices and interest rates both high, you can expect more lenders to proceed with caution.
If your credit score is below 580, you should focus on bringing your score up. If your score is between 580 and 630, you can likely get approval through various special financing programs, but you may need to come up with a larger down payment. And if your credit score is above 640, you should be able to get approved for a home price within your budget based on your income-to-debt ratio.
