If your credit score is high enough to qualify you for a home loan, you deserve congratulations. You've just passed the biggest hurdle to being a homeowner. But lenders aren't done with your credit score just yet. They use it to determine the interest rate you'll pay on the loan and what your minimum down payment needs to be. Here's how the down payment fits in:
A Lower Score Usually Means a Higher Down Payment
Your credit score indicates to lenders how likely you'll be to pay back your loan. The lower your score, the riskier you look to lenders. Your credit score might be good enough to qualify you for a loan, but it might not be what your lender considers the top tier. You generally need a score of at least 620 to get a conventional home loan. But if your score is at the minimum level, you might have to put down a larger down payment than if your score were higher, such as in the 700s.
Besides your credit score, lenders use a figure called the loan-to-value ratio, or LTV, to determine whether you get the loan. Your LTV is calculated by comparing the amount of your loan with the price of the home.
Let's say the home you want to buy costs $200,000. You want to borrow $180,000 and put down $20,000 of your own money. You would then have an LTV of 90 percent. If your credit score is on the low end, your lender might want you to lower your LTV to 80 percent. You would then only get to borrow $160,000 and would need to put down $40,000.
When your credit score is shaky, lenders feel more comfortable lending to you when you have more equity in the house. Putting down a larger down payment gives you a bigger stake in the home, making it less likely for you to default on the loan and walk away. People with a high credit score have already proven that they pay their debts, which is the reason they can put down a lower down payment and still get a loan.
About FHA Loans
The above information was about conventional loans. If you cannot afford the down payment your conventional lender requires, you might qualify for a Federal Housing Administration loan.
You need a credit score of at least 580 to get an FHA home loan, which is lower than you need to get a conventional loan. You can also have a down payment of only 3.5 percent. The federal government insures FHA loans, which is the reason lenders agree to those terms. A downside to FHA loans is that you must pay two types of mortgage insurance premiums on them.
You can find an FHA lender at all major U.S. banks and at some local banks. There are various requirements that you need to meet to qualify for an FHA loan, such as having a steady job at the same place for at least two years and having a valid Social Security number. An FHA lender can discuss all the details with you.
Remember that you always want to have the highest credit score possible when applying for a home loan. And, although your lender might allow you to make a down payment of less than 20 percent, it benefits you if you can put down 20 percent. That way, you avoid paying PMI insurance.