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What Credit Score Do You Really Need for a Mortgage?

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Love it or hate it, your credit score has a big influence over your financial life. Planning to apply for a mortgage in the near future? Your credit score can make or break your ability to qualify for a home loan.

Because your credit score is such an important part of the homebuying process, it pays to understand how lenders view it.

Credit score requirements by mortgage type

When you’re preparing to purchase a home, one of the first decisions you’ll need to make is which type of mortgage is best for you. The condition of your credit score may come into play when you are making your decision.

Here are the minimum credit score requirements for conventional, FHA, VA and USDA mortgage programs:

Mortgage TypeCredit score
Conventional620
FHA500 (10% down payment required)
580 (3.5% down payment required)
VANo set minimum (entire loan profile reviewed instead)
USDA580 (if eligible for a credit exception)
640 (for automatic approval)

Do lenders abide by minimum credit score requirements?

Under most circumstances, lenders will not issue a mortgage if your credit score falls beneath the minimum thresholds listed above. Why not? The answer lies in the secondary mortgage market.

Because lenders are working with a finite budget, it’s common for them to sell the loans they make to another company. Lenders don’t have unlimited funds to keep granting new mortgages to new customers while they wait 30 years for you to pay back your loan. At some point, the lender would run out of money.

To avoid this issue, lenders routinely package up their loans and sell them on what is known as the secondary mortgage market. Larger companies, such as banks or government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, purchase the loans (and often resell them again to investors).

For a GSE or investor to be interested in buying a loan from a lender, the loan has to meet that entity’s minimum score requirements. If a lender issued you a conventional mortgage at a credit score under 620, Fannie Mae/Freddie Mac wouldn’t be interested in buying the loan later. Instead, the lender would likely have to keep your loan on its books until you paid it off, refinanced or until the lender could find another buyer for it.

Lenders don’t want to be stuck with loans on their books. It limits the future mortgages the company can write. As a result, lenders don’t typically write loans for people who don’t meet minimum score requirements.

When it comes to FHA, VA and USDA loans, minimum credit score requirements are firm. A lender couldn’t issue these loans to applicants with lower credit scores, even if they wanted to.

Lenders might require a higher-than-minimum score

If you’re a potential homebuyer with a credit score close to the cutoff point, here’s a bit of bad news: Some lenders may require even higher scores than those listed above in order to approve your mortgage application.

Many lenders have internal policies known as lender overlays. Such overlays often feature stricter credit score requirements. This means that even if your credit score satisfies a mortgage program’s minimum requirement, it might not be high enough to satisfy every lender.

But why would lenders ask for a higher minimum credit score than is required for your loan type? In the end, it comes down to risk management.

Casey Fleming, veteran mortgage adviser in Silicon Valley and the author of The Loan Guide: How to Get the Best Possible Mortgage, offers some insight.

“Each lender has to do its own risk management/profitability equation. Higher risk means a higher cost of servicing loans when a borrower goes into default, which is much more likely at lower credit scores. Typically, lenders will either offer very good pricing but require very high scores, or they will do the opposite.”

Rick Melville, a certified mortgage planner with 24 years of experience, explains that overlays exist because “many lenders desire a higher credit score threshold to provide safety for their portfolio.”

So, although the FHA minimum median credit score requirement may be 580 on loans with a 3.5% down payment, some lenders might choose not to approve loans unless the borrower’s median score is 640 or higher.

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How your credit score can affect your home loan

Your credit score has the ability to affect more than whether your loan is approved or denied.

  • Your credit score affects how much interest you’ll be charged for your mortgage. Lower credit scores typically equal higher interest rates. Higher credit scores typically equal the opposite.
  • The size of your down payment may be affected by your credit score.
    Lower credit scores could also equal a bigger down payment requirement to qualify for a mortgage. With an FHA loan, for example, you may qualify for a low 3.5% down payment if your credit score is 580 or higher. Yet if your score falls between 500 and 579, you might have to put up 10% instead (if you can find a lender willing to approve your loan application).
  • Your monthly payment can be influenced by your credit score.
    Naturally, if a lower credit score results in a higher interest rate for your mortgage, you can expect to pay a higher monthly payment than you would have been charged otherwise. But that’s not the only way your credit score can influence the size of your monthly payment.If you finance more than 80% of a home’s value, your lender will likely require you to purchase private mortgage insurance (PMI). For conventional loans in particular, the cost of your PMI premium is influenced by your credit score. In other words, borrowers with lower credit scores pay higher PMI premiums.

Good news: Your credit score is not the only factor that matters when you buy a home

You credit score matters a great deal when you want to buy a house. It is not, however, the be-all and end-all of qualifying for a mortgage. Your credit score is just one piece of the equation.

Lenders look at factors beyond credit score to decide whether to approve your mortgage application as well, including

  • Loan-to-value ratio
    Loan-to-value (LTV) ratio describes the relationship between a property’s value and the size of the loan against it. If the home you plan to purchase costs $240,000 but appraises at $300,000, for example, the LTV would be 80% (loan amount divided by appraised value).A larger down payment could also result in a lower LTV ratio. From a lender’s perspective, the lower the LTV, the better.
  • Down payment size
    Most loans will require that you bring a down payment of a certain size to the closing table. If you can put up a larger down payment, however, you might improve your odds of qualifying or secure a better interest rate for your loan.
  • Debt-to-income ratio
    Debt-to-income (DTI) ratio measures how much of your income is used to pay your debts each month. Lenders calculate DTI by adding up your monthly debt payments and dividing them by your total gross monthly income.The more money you pay out monthly to others, the more likely you are to default on a mortgage. As a result, the less you owe (i.e., the lower your DTI), the higher your odds of being approved for a new home loan.Having money in reserve can also make you a more attractive borrower. Reserves are liquid assets you could tap into to make your mortgage payment if needed, such as

    • Checking accounts
    • Savings accounts
    • Retirement accounts
    • Investments (stocks, bonds, mutual funds, CDs, etc.)
  • Current income and employment history
    To qualify for a mortgage, you need to have a steady job and stable income, and you need to be able to prove that you do. When you apply for a mortgage, lenders will review your pay stubs, tax returns, bank statements and other information to assess your level of risk.Your income is also a key component you should consider personally when you’re figuring out how much house you can afford. Try LendingTree’s home affordability calculator to get a better idea of your ideal home price. LendingTree owns MagnifyMoney.

How to prepare your credit for a mortgage

It’s true that it can be incredibly difficult, often impossible, to qualify for a mortgage with a low credit score. But here’s the good news: With hard work and a little patience, credit scores can be improved.

Check out the following tips on how you can work to get your credit score where it needs to be.

Review your three credit reports. Your credit scores are based upon the information found in your credit reports from Equifax, TransUnion and Experian. Unfortunately, despite your creditors and the credit bureaus’ best efforts, credit reporting mistakes can sometimes happen.

If a mistake winds up on your credit reports, it can damage your credit scores whether the information is accurate or not. The only way you can be sure the information on your three credit reports is accurate is to review them yourself.

Federal law gives you the right to get a free copy of your three credit reports every 12 months via AnnualCreditReport.com.

Melville advised, “Pull the credit now if you’re planning to apply for a mortgage any time soon. It can help to know what you’re dealing with in advance.”

Correct errors on your credit reports.

Should you discover errors on your credit reports, federal law gives right to dispute those mistakes with the credit bureaus. According to the Fair Credit Reporting Act (FCRA), when you dispute an item on your credit report you disagree with, it has to be investigated.

If a credit bureau can’t verify the disputed information as accurate, the item in question must be fixed or removed from your credit report entirely, usually within 30 days.

Pay down your credit cards

Reducing your credit card debt might be another effective way to give your credit score a boost. According to FICO, you should aim to keep your balances low on credit cards and other revolving debt.

High outstanding debt can affect your score in a negative way. With credit cards specifically, using a high percentage of your available credit can indicate that you’re overextended and more likely to make late payments. Your credit scores can suffer as a result.

On the flip side, if you pay those balances down, you could be doing your credit scores (and your wallet) a big favor.

What’s next?

If you think your credit may be strong enough to qualify for a mortgage, the next step is to shop around and find the best loan offer available.

Fleming recommends to start by “meeting with an experienced, competent, ethical mortgage adviser before you go shopping for a home.

Even if you’re unsure about your credit scores, speaking with a mortgage professional might be helpful.”

He added that “reasons for low credit scores vary dramatically. Many folks find they actually hurt their scores when they try to improve them. A good mortgage adviser should be able to tell you whether your score is an issue or not, how much of an issue it is, and what would help you the most in bringing your score up (assuming you need to).”

This article contains links to LendingTree, our parent company.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Michelle Black
Michelle Black |

Michelle Black is a writer at MagnifyMoney. You can email Michelle here

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Mortgage

Should You Save for Retirement or Pay Down Your Mortgage?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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On the list of financial priorities, which comes first — paying off your mortgage or saving for retirement? The answer isn’t simple. On one hand, owning a home with no mortgage attached to it provides long term security knowing you’ll have a place to live with no monthly payment except property taxes and insurance. However, you’ll also need income to live on if you plan to retire, and how much you save now will have a big impact on your quality of retirement life.

We’ll discuss the pros and cons of whether you should save for retirement or pay down your mortgage, or maybe a combination of both.

Pros of paying down your mortgage vs. saving for retirement

The faster you pay your mortgage off, the sooner you own the home outright. However, there are other benefits you’ll realize if you take extra measures to pay your loan balance off faster.

You could save thousands in long-term interest charges

Most homeowners take out a 30-year mortgage to keep their monthly payments as low as possible. The price for that affordable payment is a big bill for interest charged over the 360 payments you’ll make if you’re in your “forever” home.

For example, a 30-year fixed $200,000 loan at 4.375% comes with a lifetime interest charge of $159,485.39. That’s if you never pay a penny more than your fixed mortgage payment for that 30-year period. Using additional funds to pay down your mortgage faster can significantly reduce this.

Even one extra payment a year results in $27,216.79 in interest savings on the loan we mentioned above. An added bonus is that you’ll be able to throw your mortgage-free party four years and five months sooner.

You’ll build equity much faster

Thanks to a beautiful thing called amortization, lenders make sure the majority of your monthly mortgage payment goes toward interest rather than principal in the beginning of your loan term. Because of that, it’s difficult to make a real dent in your loan principal for many years. You can, however, counteract this by making additional payments on your mortgage and telling the lender to specifically put those payments toward your principal balance instead of interest.

Not only do you pay less interest over the long haul with this strategy, but you build the amount of equity you have in your home much faster. And to homeowners, equity is gold — you’re closer to owning your home outright, and equity can also be a resource if you need funds for a home improvement project or another big expense.

You can access that equity as your financial needs change by doing a cash-out refinance or by taking out a home equity loan or home equity line of credit (HEL or HELOC).

You won’t lose your home if values drop

When you contribute extra money into a retirement account, there is always the risk that you’ll lose some or all of the money you invested. When you contribute money to paying off your mortgage, even if the values drop, you still have the security of a place to live, and are increasing the equity in the home, no matter how much it’s ultimately worth.

Making extra payments ensures you’ll eventually have a debt-free asset that provides shelter to you and your family, regardless of what happens to the housing market in your neighborhood.

Cons of paying down your mortgage vs. saving for retirement

There are some cases where paying down your mortgage faster might actually hurt you financially. Before adding extra principal to your mortgage payments, you’ll want to make sure you aren’t doing damage to your financial outlook with an extra contribution toward your mortgage payoff.

You might end up paying more in taxes

The higher interest payments you make during the early years of your mortgage can act as a tax benefit, so paying the balance down faster could actually result in you owning more in federal taxes. If you are in a higher tax bracket in the early (first 10 years) of your mortgage repayment schedule, it may make sense to focus extra funds on retirement savings, and let your mortgage interest deduction work for you. Of course, everyone’s tax situation is different, so you’ll have to decide (with help from an accountant ideally) if it makes sense to itemize your taxes in order to claim mortgage interest payments as a deduction.

You won’t get to enjoy the return on your paydown dollars until you sell

The only real benchmark for figuring out the value of paying down your mortgage is to look at how much equity you’re gaining over time. However, the equity doesn’t become a tangible profit until you actually sell your home. And the costs of a sale can take a big bite out of your equity because sellers usually pay the real estate agent fees.

Home equity is harder to access

The only way to access the equity you’ve built up is to borrow against it, or sell your home. Borrowing against equity often requires proof of income, assets and credit to confirm you meet the approval requirements for each equity loan option. If you fall on hard financial times due to a job loss, or are unable to pay your bills and your credit scores drop substantially, you may not be able to access your equity.

Pros of saving for retirement vs. paying down your mortgage

Depending on your financial situation and savings habits, it may be better to add extra funds monthly to your retirement account than to pay down your mortgage. Here are a few reasons why.

You may earn a higher return on dollars invested in retirement funds

The growth rate for a stock portfolio has consistently returned more than housing price returns. The average return in the benchmark S&P stock fund is 6.595% for funds invested from the beginning of 1900 to present, while home values have increased just 0.1% per year after accounting for inflation during that same time period.

Assuming your portfolio at least earns 7%, if you consistently invest your money into a balanced investment portfolio, you can expect to double your money every 10 years. There aren’t many housing markets that can promise that kind of growth.

Retirement funds are generally easier to access than home equity

Retirement funds often give you a variety of options for each access, with no income or credit verification requirements, and only sufficient proof of enough funds in your account to pay it back over time. For example, a 401k loan through the company you work for will just require you to have enough vested to support the loan request, and sufficient funds left over to pay it off over a reasonable time.

Just be cautious about making a 401k withdrawal, which is treated totally differently than a loan. You aren’t expected to pay it back like you would a 401k loan, but you could get hit with taxes and penalties.

Cons of saving for retirement vs. paying down your mortgage

You’ll need to weather the ups and downs of the market

Most people who have invested money in the stock market or tracked the performance of their 401k over decades have stories about periods when the value of those investments dropped substantially. While the 7% return on investment is a reliable long term indicator how much your retirement fund might earn, the path to that return is hardly linear.

For example, if you were considering retirement between 1999 and 2002, you may have had to delay those plans when the S & P plummeted over 23% in value in 2002. If you look at each 10-year period since the 1930s, every decade has been characterized by periods of ups and downs.

Calculating the benefit of paying down your mortgage vs. saving for retirement

If you’re torn as to what to do with that extra cash or windfall, let’s look at an example of someone who has an extra $200 to put into either their nest egg or their mortgage each month for the next 30 years.

For this scenario, we’re going to assume their retirement account earns an average 7% rate of return and that their mortgage loan balance is $200,000.

Here’s how much they’d save:

Savings From Paying $200 per Month Down on Your Mortgage
Years PaidMortgage Interest SavingsExtra Equity in HomeTotal Interest Savings and Equity Built Up
10 years$6,040$30,039$36,079
20 years$28,529$76,529$105,058
22 years 6 months$50,745$200,000$250,745

One thing you may notice about the mortgage savings chart — it includes how much extra equity you’re building. Often only the mortgage interest savings is cited when people look at how much you save with extra payments, but that ignores the fact that you’re building equity in your home much faster as well. So not only do you save over $50,000 in interest with your extra contribution, you replenish $150,000 of equity that was used up by your mortgage balance.

As you can see, adding that extra $200 to their mortgage principal each month saved them about $200,000 in the long haul — but the real savings don’t stop there.

By adding an extra $200 to their mortgage payment each month, this borrower turned their 30-year loan into a 22-and-a-half year loan and became mortgage debt-free seven years faster.

That means, in addition to saving $50,000 in interest savings and gaining $200,000 of equity, they also no longer have a mortgage payment. That frees up $998.57 per month that they can now use as discretionary income. That’s an extra $89,871 they could potentially save over that 7.5 year period.

When you add that to the $250,745.41 they saved on mortgage interest and earned in home equity, they’re looking at a total savings of $340,616.

That gives the mortgage paydown a $54,000 net positive edge over saving that extra $200 for retirement, as you can see in the table below.

Savings From Contributing $200 per Month to a Retirement Fund
Years PaidRetirement Balance
10 years$34,404
20 years$102,081
30 years$235,212

The one caveat for this retirement calculation is we assumed the saver was starting at a $0 investment balance. If they already had a healthy balance in their nest egg, they might actually come out in better shape than paying down their mortgage.

There are clearly benefits to each option, and you should consider running your own calculations with your real numbers to get the best answer for yourself.

Paying down your mortgage and saving for retirement at the same time

There’s a fair case to be made for both paying down your mortgage and saving more for retirement, but why choose? If you’re somewhat on track with your retirement savings goals, and like the idea of having your mortgage paid off quicker, you could allocate a certain amount to each.

Pick a number you feel comfortable paying to your principal every month, and then to your 401k, and put it on autopilot for a year. Any time your income increases, or you get bonuses, divide up the amount between principal pay down and retirement additions.

Let’s look at what happens if you evenly divide up your $200 per month between investing your retirement and paying down your mortgage. We’ll use the same $200,000 loan at 4.375% referenced above, and look at the lifetime results.

Savings From Paying $100 Down on Your Mortgage Until Paid Off
Years PaidInterest SavingsExtra Home EquityTotal Interest Savings and Equity Built Up
10 years$3,020$15,020$18,040
20 years$14,265$38,265$52,350
25 years$30,534$200,000$230,534
Savings From Contributing $100 to a Retirement Fund for 30 Years
Years PaidRetirement Balance
10 years$17,202
20 years$51,401
30 years$117,607

Balancing the $100 investment in both strategies still yields a six-figure retirement balance after 30 decades, a debt-free house after 26 years, and shaves off $30,000 in mortgage interest expense. If you don’t like putting all your eggs into one financial basket, this may balance the risks and rewards of each option.

Final thoughts

Looking at the short term and the long term may provide you with the best framework for making a good decision about how to spend dollars on retirement versus extra mortgage payments. Be wary of any financial professional that tells you one path is absolutely better than another.

Having a stable source of affordable shelter is equally as important as having enough income to live when you retire, so a balanced approach to paying down your mortgage and savings for retirement may help you accomplish both goals.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

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Life Events, Mortgage

What Is Mortgage Amortization?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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One of the biggest advantages of homeownership versus renting is each mortgage payment gradually pays off your mortgage and builds equity in your home. The difference between your home’s value and the balance of your loan is home equity, and your equity grows with each payment because of mortgage amortization.

Understanding mortgage amortization can help you set financial goals to pay off your home faster or evaluate whether you should refinance.

What is mortgage amortization?

Mortgage amortization is the process of paying off your loan balance in equal installments over a set period. The interest you pay is based on the balance of your loan (your principal). When you begin your payment schedule, you pay much more interest than principal.

As time goes on, you eventually pay more principal than interest — until your loan is paid off.

How mortgage amortization works

Understanding mortgage amortization starts with how monthly mortgage payments are applied each month to the principal and interest owed on your mortgage. There are two calculations that occur every month.

The first involves how much interest you’ll need to pay. This is based on the amount you borrowed when you took out your loan. It is adjusted each month as your balance drops from the payments you make.

The second calculation is how much principal you are paying. It is based on the interest rate you locked in and agreed to repay over a set period (the most popular being 30 years).

If you’re a math whiz, here’s how the formula looks before you start inputting numbers.

Fortunately, mortgage calculators do all the heavy mathematical lifting for you. The graphic below shows the difference between the first year and 15th year of principal and interest payments on a 30-year fixed loan of $200,000 at a rate of 4.375%.

For the first year, the amount of interest that is paid is more than double the principal, slowly dropping as the principal balance drops. However, by the 15th year, principal payments outpace interest, and you start building equity at a much more rapid pace.

How understanding mortgage amortization can help financially

An important aspect of mortgage amortization is that you can change the total amount of interest you pay — or how fast you pay down the balance — by making extra payments over the life of the loan or refinancing to a lower rate or term. You aren’t obligated to follow the 30-year schedule laid out in your amortization schedule.

Here are some financial objectives, using LendingTree mortgage calculators, that you can accomplish with mortgage amortization. (Note that MagnifyMoney is owned by LendingTree.)

Lower rate can save thousands in interest

If mortgage rates have dropped since you purchased your home, you might consider refinancing. Some financial advisors may recommend refinancing only if you can save 1% on your rate. However, this may not be good advice if you plan on staying in your home for a long time. The example below shows the monthly savings from 5% to 4.5% on a $200,000, 30-year fixed loan, assuming you closed on your current loan in January 2019.

Assuming you took out the mortgage in January 2019 at 5%, refinancing to a rate of 4.5% only saves $69 a month. However, over 30 years, the total savings is $68,364 in interest. If you’re living in your forever home, that half-percent savings adds up significantly.

Extra payment can help build equity, pay off loan faster

The amount of interest you pay every month on a loan is a direct result of your loan balance. If you reduce your loan balance with even one extra lump-sum payment in a given month, you’ll reduce the long-term interest. The graphic below shows how much you’d save by paying an extra $50 a month on a $200,000 30-year fixed loan with an interest rate of 4.375%.

Amortization schedule tells when PMI will drop off

If you weren’t able to make a 20% down payment when you purchased your home, you may be paying mortgage insurance. Mortgage insurance protects a lender against losses if you default, and private mortgage insurance (PMI) is the most common type.

PMI automatically drops off once your total loan divided by your property’s value (also known as your loan-to-value ratio, or LTV) reaches 78%. You can multiply the price you paid for your home by 0.78 to determine where your loan balance would need to be for PMI to be canceled.

Find the balance on your amortization schedule and you’ll know when your monthly payment will drop as a result of the PMI cancellation.

Pinpoint when adjustable-rate-mortgage payment will rise

Adjustable-rate mortgages (ARMs) are a great tool to save money for a set period as long as you have a strategy to refinance or sell the home before the initial fixed period ends. However, sometimes life happens and you end up staying in a home longer than expected.

Knowing when and how much your payments could potentially increase, as well as how much extra interest you’ll be paying if the rate does increase, can help you weigh whether you really want to take a risk on an ARM loan.

The bottom line

Mortgage amortization may be a topic that you don’t talk about much before you get a mortgage, but it’s certainly worth exploring more once you become a homeowner.

The benefits of understanding how extra payments or a lower rate can save you money — both in the short term and over the life of your loan — will help you take advantage of opportunities to pay off your loan faster, save on interest charges and build equity in your home.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

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