Lenders require different FICO scores for different types of home loans. An FHA mortgage loan requires a FICO score of 580 while others require higher scores.
Let us discuss what is a FICO score, how it is calculated, and what are the FICO score requirements for different types of home loans.
What is a FICO Score?
A FICO score is a grade assigned by Fair Isaac Corporation that reflects the creditworthiness of the person it is assigned to. It is a person’s credit score compiled by FICO (the organization).
Three credit bureaus report and record your financial history; Experian, TransUnion, and Equifax. FICO receives credit reports from all three bureaus and compiles them.
Then, using a standard formula, FICO assigns a score ranging from 300 to 850. The higher the credit score the better it is.
FICO score can be categorized into five grades:
- 300-579: Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very good
- 800-850: Excellent
FICO uses several credit scoring models. These are the grading versions that are updated regularly. Also, all three credit bureaus may reflect a FICO version of their own grading model.
However, your FICO score will generally reflect the same credit score or it would translate into the same after a few adjustments.
What FICO Score is Used for Home Loans?
Lenders would immediately look at the credit score of a borrower before approving the loan application. It is the summary of the creditworthiness of the borrower.
The FICO score required for a home loan depends on the type of loan you apply for. Also, different lenders may set different credit score requirements depending on several factors.
Let’s briefly discuss the FICO score requirements for major home loans.
FICO Score Required for FHA Loan
The Federal Housing Authority (FHA) does not offer loans directly. It provides strict guidelines to lenders to offer flexible loan terms to homebuyers.
FHA mortgages are particularly useful for first-time homebuyers. These loans require a small down payment and come with the backing of FHA security.
Therefore, FHA lenders including banks, credit unions, and private lenders will often accept lower FICO scores. As a general rule, FHA mortgages require a FICO score of 580.
You may apply for an FHA loan with a FICO score of 500 as well if you raise the down payment to 10% of the loan amount.
FICO Score Required for USDA Loan
These loans are backed by the US Department of Agriculture. USDA mortgage loans are offered to low-income borrowers living in rural and suburban areas.
Borrowers of USDA loans require a FICO score of 640 or above. However, the exact requirement may change depending on the property location and value.
Lenders may put their requirements or demand a higher credit score from risky borrowers as well.
FICO Score Required for VA Loan
These loans are backed by the US Department of Veteran Affairs. These are offered to qualifying service members, surviving spouses, and veterans.
Borrowers can apply for a VA loan without a credit score and do not require private mortgage insurance as well.
Most lenders will require a minimum score of 620 for VA loan applications.
FICO Score Required for Conventional Loan
Conventional home loans are offered by banks, savings, and loan associations. No US government agency backs these commercial home loans.
So, lenders will typically put strict FICO score requirements. They’ll usually look for a credit score of 740+ categorized as “Very Good”.
Although you may apply for conventional home loans with a lower credit score of 620 or less but it will make the application approval difficult.
FICO Score Required for Jumbo Loan
Jumbo loans are large home loans as the name suggests. These loans are also offered by commercial banks and private lenders and do not come with the backing of any US department.
Due to the high perceived risk of jumbo loans, lenders will typically require an excellent credit score of 700+ and often in the range of around 800.
How Does FICO Score Affect Your Loan Application?
A credit score reflects the creditworthiness of a borrower. It scales the riskiness of a borrower by quantifying the financial risks associated with borrowing money.
Lenders will look for a quick method to quantify these financial risks. A credit score does that job exactly by considering several factors and assigning a compiled score.
A credit score shows the ability of a borrower to repay the loan amount. So, it helps lenders to assess what’s the financial capability of a borrower to repay the loan amount being applied.
Therefore, different lenders will set different credit score requirements for different types of loans. That’s the reason you see lenders demanding a different credit score for similar loan types.
In short, your credit score shows the ability or inability to repay the loan and helps them decide on the loan application logically.
FICO Score Impact on Loan Interest Rate
Apart from assessing the creditworthiness of the borrower, FICO scores play a crucial role in deciding the interest rate of a loan.
As a rule of thumb, the higher the credit score lower the interest rate charged by lenders. However, many other factors like the market interest rate also affect the decision.
For example, if we use the MyFICO online calculator to find the current interest rate on a 30-year mortgage with different credit scores, it shows the following interest rates.
- Credit Score: 760-850 – Interest Rate: 4.951 %
- Credit Score 700-759 – Interest Rate: 5.173 %
- Credit Score 680-699 – Interest Rate: 5.35 %
- Credit Score 660-679 – Interest Rate: 5.564 %
- Credit Score 640-659 – Interest Rate: 5.994 %
- Credit Score 620-639 – Interest Rate: 6.54 %
When you translate it into an interest amount, the total interest amount drops from $192,738 to $138,269.
It means if your credit score improves from 620 to 760, you can save almost $54,470 over the life of the loan.
How is FICO Score Calculated?
By now, you must have an idea of how important your FICO score is to apply for a home loan. Now, it’s time to revise how it is calculated to get a better idea of how it works.
There are five major contributors to your credit score:
- Payment history: 35%
- Total Remaining Balance of All Loans: 30%
- Length of your credit history: 15%
- Credit mix: 10%
- New credit: 10%
While you cannot control a factor like the length of your credit history, you can certainly work to improve other factors.
This scoring formula is developed by FICO and is widely accepted. Credit bureaus like Experian follow the same rules and other bureaus calculate the credit score using similar metrics as well.
How to Improve FICO Score?
Once you know how the FICO score is calculated, you can take a few steps to improve it. As shown above, it has a great impact on the total cost of borrowing in the long term.
Here are a few quick tips for you to improve your credit score.
- Open a credit account as soon as possible to start your credit history.
- Do not close older credit lines immediately when you’ve repaid the loans.
- Check your credit report and find if there are any errors.
- Do not delay your monthly payments on all types of credit facilities, including a credit card.
- Keep your credit utilization ratio low.
- Apply for different types of loans to create the credit mix.
- Do not apply for several loans with different borrowers too frequently.
A building credit score takes time there are no quick fixes to improve the credit score. So, patiently practice these guidelines and improve your score gradually.
Can You Get a Home Loan Without a FICO Score?
Yes, you may get a home loan without a FICO score in some cases as well. For instance, if you apply for a VA loan, you do not need a FICO Score.
However, it does not guarantee loan approval. You may apply for a loan with an average or bad credit score as well.
Lenders will eventually decide on your loan application by considering different factors like your monthly income, debt-to-income rate, credit score, credit history, and so on.
