What credit do you need to buy a house

Whether you’re in a buyer’s or a seller’s market, you'll want to buy a home as soon as you come across the right one. But it's not always that simple. There are many financial issues that will determine whether you'll be able to purchase the house, as well as the terms of your mortgage. Understanding the requirements to buy a house can make the home buying process easier to navigate.

Key Takeaways

• There are several key requirements to buy a house to be aware of before looking for a mortgage.
• Some of the most important requirements for buying a home include a down payment, a good credit score, and an acceptable debt-to-income ratio.
• Homebuyers also need to be prepared for closing costs, which are due before the final paperwork on the home is signed.
• Ask the lender what documents you'll need to ensure there are no problems with your application.

Requirements To Buy a House

For most people, buying a house means getting a mortgage. According to the National Association of Realtors, 93% of first-time buyers finance their home purchase while 83% of repeat buyers do so.

The mortgage process typically is different for every buyer. But typically, there are six boxes to check off when getting a home loan;

• Down payment
• A lender
• Credit scores
• Debt-to-income ratio
• Closing costs
• Documentation

A good real estate agent can also be helpful when finding the right home to buy. Eighty-seven percent of people who bought a home in 2021 did so with the help of a trusted real estate agent.

Important

When choosing a real estate agent, consider their background, credentials, and experience. Asking friends and family for referrals can also help with finding the right person to work with.

Requirement #1: Down payment

The first requirement to buy a home is a down payment. This is the money you pay upfront to offset the amount you need to borrow.

“Lenders have tightened the requirements since the economic crisis in 2008,” says Karen R. Jenkins, president and CEO of KRJ Consulting. “As a result, prospective borrowers seeking to purchase a home must have some ‘skin in the game’ to qualify for a home.”

The amount you need for a down payment can depend on the type of loan you're hoping to get. For example, FHA mortgages require a minimum down payment of 3.5% of the purchase price. If you're looking at a conventional loan, on the other hand, you'll need at least 20% down to avoid private mortgage insurance (PMI).

Note

USDA and VA loans have no down payment requirements.

If you're having trouble saving the money for a down payment, there are some options you might consider. Down payment assistance programs, for example, can offer financial help with down payments and closing costs for eligible borrowers. You could also ask for a down payment gift from a family member. Keep in mind that there may be limits on down payment gifts and you'll need a properly documented down payment gift letter.

Requirement #2: A lender

Your choice of lender matters as it can influence the interest rate you pay for a mortgage loan. The lower your rate, the less you'll pay to buy a home over the life of the loan. This is why it's important to shop around and compare mortgage lenders.

You can start off by checking with your own financial institution (FI). You may be able to get a competitive rate because you already do business with them. And don't rule out credit unions, small community banks, and even online lenders. The more lenders you check, the more likely it is that you'll get a really good rate.

A great tool for researching and comparing interest rates is a mortgage calculator. This tool gives you an idea of your potential costs before you even meet with a mortgage broker.

Tip

Getting pre-approved for a home loan could give you an edge when making an offer on a property, as it shows the seller that you're serious about buying.

Requirement #3: Credit score

Mortgage lenders consider your entire financial situation when applying for a loan but your FICO score can take center stage. Your credit scores indicate to lenders how likely you are to repay what you borrow. If you have a bad credit score or, even worse, no credit history at all, it will be very difficult to qualify for a mortgage.

So what credit score do you need for a mortgage? Again, the answer depends on what type of mortgage loan you're seeking.

Amy Tierce, a senior loan officer with Radius Financial Group, notes that although the Federal Housing Administration (FHA) offers financing options to borrowers with a credit score as low as 500, most lenders have their own requirements. So it may be a challenge to find a lender who'll work with a borrower with a credit score below 620 or 640.

Checking your credit scores before applying for a home loan can give you a better idea of whether you meet the lender's requirements to buy a house. This can also give you a feel for what kind of interest rates you're likely to pay for a mortgage.

Requirement #4: Debt-to-income ratio

Debt-to-income ratio or DTI represents the percentage of your income that goes toward debt repayment each month. You can figure this out by adding up all your monthly debt payments and dividing that figure by your gross income each month. The lower this number is, the better for meeting the requirements to buy a house.

Banks use your DTI to determine whether you can afford to purchase a home. The Consumer Financial Protection Bureau has rules stating that the debt-to-income ratio cannot exceed 43%. If your DTI exceeds this amount, you may have a harder time getting a mortgage.

So how can you reduce your DTI to meet the requirements for a mortgage? Paying down some of your debt is an obvious choice. You could also improve your debt-to-income ratio by finding ways to boost your earnings. But consider whether that higher income is sustainable; otherwise, you may not be able to afford mortgage payments for the long term.

Requirement #5: Closing costs

Closing costs are fees and charges you pay at closing. If you don't pay these fees, the loan documentation can't be signed and the mortgage process isn't complete. Typical closing costs can include:

• Credit report fees
• Application fees
• Recording fees
• Title insurance fees
• Underwriting or processing fees
• Closing fees
• Escrow fees
• Origination fees
• Prepaid interest
• Survey fees

Your lender should provide you with a detailed estimate of what you'll have to pay at closing. On average closing costs run from 2% to 5% of the home's purchase price. So if you're buying a $300,000 home then you might pay anywhere from $6,000 to $15,000 at closing.

Again, you could look into down payment and closing cost assistance programs that can cover some or all of these expenses. But if you don't qualify, you'll need to include a line item for closing costs in your home buying budget.

Requirement #6: Documentation

Making sure you have all your ducks in a row before you apply for your mortgage will help the process go much smoother. Insufficient documentation can delay or even stop the loan approval process altogether, so you need to find out what you have to bring to the table.

“Your lender should have a full and complete checklist of required documentation to support your loan application depending on your employment and income situation,” Tierce says. “If you are starting with a pre-approval, be sure that the lender asks for all documentation for the process since a pre-approval without thorough documentation review is useless. Something can be missed that could result in your loan being declined later if the pre-approval process is not extremely well documented.” 

What is pre-approval? According to Jenkins, it's "preliminary approval based on what the borrower stated on the application—income, debt, assets, employment, etc. The actual approval process validates the income, assets, and debt using various methods such as pay stubs, tax returns, bank statements, W2s, and employment verifications.”

Tierce adds that “in competitive markets, sellers and realtors won’t even consider an offer without knowing that the buyer is pre-approved.” Additional documents could be requested at a later date or throughout the process. “The underwriting process is exhaustive, and some documents may bring up questions or concerns that require additional documentation. Just take a deep breath and give the lender everything they ask for, as quickly as possible, to get your approval completed.”

What Credit Score Is Needed to Buy a House?

The minimum credit score need to buy a house can vary based on the type of loan. For an FHA loan, for example, it's possible to qualify for a mortgage with a credit score as low as 500. Other types of home loans, however, might require a credit score of 640 or better.

How Much Money Do I Need To Put Down on a Home?

You'll need to put down at least 20% on a conventional home loan if you want to avoid paying private mortgage insurance (PMI). FHA loans have a down payment requirement as low as 3.5% while USDA and VA loans have no down payment requirement at all.

What Documents Do I Need To Apply for a Mortgage?

The kinds of documents you'll need to apply for a home loan can include pay stubs, tax returns, bank statements, and investment account statements. The lender should ask for consent to pull your credit reports and credit scores as well.

How Much Money Will I Need for Closing Costs?

Closing costs for a home purchase typically range from 2% to 5% of the home's purchase price. The more expensive the home, the more money you'll likely need to finalize the closing.

The Bottom Line

Before you can think about buying your dream home, you need to be sure that your finances are in order and that you've prepared wisely and thoroughly before the mortgage-approval process even begins. Going through a checklist of requirements to buy a home can help ensure that you're as prepared as possible when you're ready to buy.