As mortgage rates tumble to multi-year lows, there’s been a massive surge in refinances and new mortgage applications. This post will look at the average credit score to quality for a mortgage.
The drop in mortgage rates is one of the key reasons why I don’t think there will be a housing downturn as vicious as the one we saw between 2008 – 2010. In fact, the housing market is stronger than ever as we exit the pandemic.
If you want to get a better indication of what the future might look like, simply check out the performance of a homebuilding ETF like XHB. Homebuilders and home-related stocks performed tremendously as investors hunt for yield.
In addition to lower interest rates, higher lending standards post-financial crisis and the desire to own real assets in an inflationary environment all support a strong housing market.
Gone are the days of negative amortizing liar loans to people with terrible credit. It has become far more difficult to get a mortgage today. Let’s look at some data.
The Average Credit Score To Qualify For A Mortgage
According to the latest quarterly report on household debt and credit by the New York Fed, 9 out of 10 U.S. mortgages go to borrowers with a score of 650 or better. Three quarters go to borrowers with scores of better than 700. Meanwhile, the average credit score for the 50th percentile is about 760.
Here is a graphical representation of the average credit score at origination.
Based on my experience refinancing multiple mortgages multiple times since 2003, having a credit score under 700 is not going to cut it. You now need a credit score of 760 or higher to qualify for the best rates on average. Even a 760 might not offer the best rate based on my current refinance where the loan officer started the application process by asking if I had a credit score of over 800.
If you do end up qualifying for a mortgage with a less than a 760 credit score, your lender will likely be charging you 0.125% – 0.75% more than if you had had a 760+ credit score.
FICO Score Ranges
Stop thinking that a credit score above 670 is “good” according to FICO. It really isn’t. Just like how it’s not good the average American has a median net worth of only about $87,000, has never traveled abroad, and will likely die younger than they are supposed to due to cardiovascular diseases.
Being average or median is not good when it comes to our finances. We are in a winner-take-all society.
Mortgage Originations By Credit Score
To highlight this winner-take-all reality, take a look at this mortgage originations by credit score chart by the NY Fed.
The light blue and dark grey sections indicate qualified borrowers with credit scores of 720+. They account for roughly 80% of all mortgages. Notice how the light blue line is gaining in percentage since 2009.
You need a minimum of 620 to qualify for a government-backed loan by Fannie Mae and Freddie Mac. However, the government, in all its wisdom, allows you to qualify for a Federal Housing Administration mortgage with a credit score as low as 500 if you can make a down payment of at least 10%.
When a downturn comes, borrowers who received government-backed loans will likely suffer the highest default rates. Their defaults will likely put negative pressure on higher credit score borrowers.
Wait Until A Credit Score Of 720+ To Get A New Mortgage
Owning a home is not a right.
Pre-2008, too many people, who really couldn’t afford to, bought homes. While we can certainly blame lenders for lowering their credit standards and coming up with creative mortgages to entice unwary borrowers, we should also not shirk responsibility for our decisions.
The easy way to save homebuyers from potential loss and save the economy from potential catastrophe is to not take out a mortgage until you have a credit score of 720 or higher, instead of the current 620 or higher. This way, if things go south, default rates won’t increase as much as they would for borrowers with lower credit scores.
The idea is similar to not eating a cookie until you’ve run at least the number of miles it takes to burn off that cookie. If you don’t, you will eventually get out of shape. The idea is also similar to not buying a car until you make 10X its cost in annual salary. Although the 1/10th rule for car buying is extreme, if you follow it, you’ll likely never experience car buying remorse.
Average U.S. Credit Score Hits A New High
Since 2012, the housing market has had a tremendous bull run. There should be no urgency to buy a home at near record-high prices without the best mortgage terms. Instead, I would work to improve your credit score to 720+ before applying for a mortgage.
The five main components that determine your credit score are: Payment History (35%), Amounts Owed (30%), Length Of Credit History (15%), New Credit (10%), and Types Of Credit Used (10%).
The weightings of each component are rough estimates that vary from person to person. For example, someone who just started taking out credit may have a lower percentage weighting in the Length Of Credit History component vs. someone who has used credit for over 30 years.
The main way to improve your credit score is to always pay your debt on time for as long as possible. Do not try and game the FICO scoring system. Keep things simple.
When it comes to taking on debt, stay disciplined.
Take Advantage Of Low Mortgage Rates
Check out Credible, one of the largest online lending platforms today that will get lenders to compete for your business. Fill it your needs and get no-obligation real quotes from qualified lenders in under three minutes. The process is easy and free. I was about to refinance my mortgage in 2019 and get an awesome new 7/1 ARM purchase loan in 2020.
Achieve Financial Freedom Through Real Estate
Real estate is my favorite way to achieving financial freedom. It is a tangible asset that is less volatile, provides utility, and generates income. By the time I was 30, I had bought two properties in San Francisco and one property in Lake Tahoe. These properties now generate a significant amount of mostly passive income.
In 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates. I did so by investing $810,000 with real estate crowdfunding platforms. With interest rates down, the value of cash flow is up. Further, the pandemic has made working from home more common.
Take a look at my two favorite real estate crowdfunding platforms. Both are free to sign up and explore:
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified eREIT is the way to go.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. If you have a lot more capital, you can build you own diversified real estate portfolio.
Readers, what is your credit score? If you have recently applied for a new mortgage or mortgage refinance, how has your experience been? What mortgage rates are you getting? Do you think we should raise the credit score minimum to qualify for a mortgage to help strengthen the economy?