The recent influx of historically low mortgage rates has been a boon to more creditworthy borrowers. The best deals on home loans go to borrowers with credit scores above 740, and many Americans who have refinanced or taken out mortgages in the past year have boasted credit scores near 800, a near-perfect sign.
But most Americans have credit scores that are 100 points below those high levels. If your credit score is less than 740 — and most Americans fall in the range of 710 or lower, according to the Experian Credit Bureau — you can still get a mortgage or refinance your existing loan.
However, you will have to choose between paying a slightly higher interest rate on a conventional loan or paying a higher mortgage fee through the Federal Housing Administration or the US Department of Veterans Affairs.
credit score gap
Your credit score is the biggest factor in determining your interest rate. The highest possible credit score in the FICO system is 850. A score above 740 is considered excellent.
According to Experian, half of Americans age 56 or younger have credit scores in their 60s or lower. While the average credit score for a baby boomer is 755, the average credit score for millennials is 678. Even Generation X, who turns 50, has a median credit score of just 699, Experian reports.
“The baby boomer generation and the silent generation are raising the average for everyone,” says Ellis Glink, CEO of Best Money Moves, a financial wellness company.
In late 2020 and early 2021, a mortgage borrower’s median credit scores reached a record high of 788, according to the Federal Reserve Bank of New York. The typical credit score for mortgage borrowers fell to 781 in the third quarter. By contrast, during the era of loose lending that led to the Great Recession, the average mortgage borrower’s credit score fell to 707.
Meanwhile, only a quarter of borrowers who took out loans to buy homes during the summer months had credit scores below 729. Only 10 percent had credit scores below 677, according to New York Federal Reserve data.
If your credit report looks good but not so good, don’t despair: you can still qualify for a loan. However, you will have to make a trade-off, either by paying a little more for a conventional loan or by taking another type of loan with competitive interest rates but higher fees.
Option 1: Pay more for a conventional loan
For most borrowers, Mortgages backed by Fannie Mae and Freddie Mac offer the best value. These loans offer the best rates to borrowers with credit scores of 740 or higher.
However, you can still qualify for a conventional loan with a credit score as low as 680, says Rocke Andrews, owner of the broker in Lending Arizona in Tucson.
The downside is that you will pay a higher interest rate. If you’re discounting at least 5 percent on the property, expect to pay an additional 0.375 percentage points.
On a 30-year mortgage for $300,000, that’s about $60 a month. In other words, the penalty for having a credit score less than excellent is about $720 per year.
Option 2: Choose an FHA loan or VA loan
The FHA mortgage program is designed for homeowners who cannot qualify for traditional loans, either due to credit problems or lack of funds for a down payment. FHA loans are available to borrowers with credit scores as low as 580.
While FHA interest rates are competitive, there is a costly problem: All FHA loans require the borrower to pay mortgage insurance premiums. There is an upfront mortgage insurance premium of 1.75 percent of the loan amount — say $300,000, $5,250.
FHA loans also charge an annual mortgage insurance premium of up to 1.05 percent, which can add hundreds to your monthly payment.
VA loans are available to active and former members of the US military. They don’t need a minimum credit score, but they come with a 2.3 percent financing fee — or $6,900 on a $300,000 loan.
How to improve your credit score
While you can qualify for a loan with less than perfect credit, you should continue to strive to increase your score on future loans. Three tips:
Pay on time. Payment history is the most influential factor with both FICO and VantageScore credit scores. With FICO in particular, your payment history equals 35 percent of your credit score. Late payments – even sometimes – can have a severe negative impact on your credit score. If you need help breaking the habit of paying late, automatic payments and an emergency fund can work to your advantage.
Reduce your credit utilization rate. After your payment history, your debt relative to the amount of credit you have is the next most important factor in your credit score. FICO bases 30 percent of your credit score on the “Amounts Due” category of your credit reports. Your credit utilization ratio—the relationship between your credit card balances and limits—has a huge impact here. When you pay off your credit card balances and lower your usage as a result, your credit score may improve. To quickly determine your current ratio, check out Bankrate’s credit utilization ratio calculator.
Don’t apply for new accounts too often. When you apply for a new credit line, a difficult inquiry is recorded on your credit report. This type of inquiry has the potential to temporarily lower your score. A serious credit query will remain on your credit report for 24 months and may affect your credit score for the first 12 months.
How to improve your credit score