If you're hoping to buy a home, one number you'll want to get to know well is your credit score. Also known as credit rating or FICO score (named after the company that created it, the Fair Isaac Corporation), this three-digit number is a numerical representation of your credit report, which outlines your history of paying off debts.
Why does your credit score matter?
When looking to purchase a home, there are two potential ways that you could use to pay for your purchase:
1) You can pay cash for your home: Oftentimes, cash is money you have saved up, inherited, has been gifted to you, etc. This is money that you own free and clear and you are at liberty to spend it without being accountable to anyone for how you spend it, when you spend it, and you have no obligation to repay it. In this case, you take on the whole risk when you spend it and whatever decisions you make regarding the use of the funds only affects you directly.
2) The second way to fund your home purchase is by taking out a loan (also known as a mortgage) to pay for the purchase. Taking out a loan or a mortgage means you are looking to use some other money other than your money ie using other people's money be it family member(s), employer, a friend, or from a corporate body eg banks, mortgage companies whose sole business is lending. The goal always is to repay this type of loan with or without interest within a specified time. In this case, someone else bears full or partial risks when allowing you to borrow money for the purchase of the home. Quite often, they would want to ensure they reduce their risks as much as possible by assessing your financial situation to determine if they should or should not lend you money.
Most housing loans today are obtained through lenders. The lender lends money for a profit and is, therefore, looking to make sound and secure investments, while taking on minimum risk as much as possible to prevent losses thereby ensuring profitability. Lenders need reassurance that when you borrow money, that you will repay them. One way they assess your ability to repay a loan is to scrutinize your credit report for your credit history and credit score along with other information such as employment history and proof of income, to determine whether to lend to you, how much to lend to you and at what interest rate.
A lower credit or FICO score proves that you defaulted on past loans (whether they were credit cards, car loans, student loans, leases, etc) which presents you as a high-risk borrower to lenders while a higher credit score proves that you have reliably paid off past debts or are consistent in making payments on your loans in a timely manner thereby presenting you as a low-risk borrower to lenders. A proven track record of repaying past loans makes you a more appealing candidate to a lender and these lenders strive to do business with you. So your credit score matters! It can help you qualify for a home loan, a car loan, a business loan, a new lease, etc. Which brings us to an important question: What type of score is best to buy a house?
Credit scores typically range from 300 to 850, with 850 being a perfect credit score. Although each creditor has slight variations in what they consider a good or great credit score, the following is the general rule that's held:
An excellent credit score ranges from 750 to 850, Lenders view you as an exceptional borrower, the risk is low and you can be relied upon to pay your bill and on time. You are likely to get the best interest rates
A very good credit score range from 700 to 749; Lenders view you as a dependable borrower, they view your score as above-average affording you great interest rates
A good credit score ranges from 650 to 699; Most lenders will lend to you at average interests rates
Fair credit score from 580 to 649; Some lenders will lend to you with slightly higher interest rates,
Scores below 580 are deemed poor.
Low credit scores may cause lenders to decide against lending to you.
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While FICO score requirements will vary from lender to lender, a good or excellent credit score generally means you'll have little trouble if you hope to score a home loan. Lenders will want the business of homebuyers with good credit, and may try to entice them to sign on with them by offering loans with the lowest interest rates, says Richard Redmond at All California Mortgage in Larkspur and author of “Mortgages: The Insider’s Guide.”
Since a lower credit score indicates that a borrower has had some, poor debt management like late payments, skipped or failed to make payments or other negatives, a lender may see this buyer as high risk and more likely to default on their home loan. All that said, a low credit score doesn't necessarily mean you can't get a home loan, but it may be tough. You may still get a loan but with higher interest rates, and you may need to pay down balances, put down larger down payments etc. to be approved