How does your credit score impact your mortgage application?

The process of applying for a mortgage can be complex and intimidating, particularly for first-time homebuyers. One of the most crucial elements of this process is the credit score, a number that lenders use to assess an applicant's creditworthiness and likelihood of repaying the loan. But what exactly is a credit score, and how does it affect the mortgage application process? More importantly, how does it impact foreign nationals and US consumers who may not fit the traditional mold?

Key Takeaways

• Credit scores play a pivotal role in traditional mortgage applications, influencing approval, interest rates, loan amounts, and terms.
• Despite their importance, credit scores have limitations and may not fully capture an individual's ability to repay a loan, particularly for foreign nationals.
• Foreign nationals represent a significant segment of the U.S. residential real estate market, with $54.4 billion in property purchases from April 2020 to March 2021, despite limitations to accessing US mortgages.

Understanding credit scores

A credit score is a numerical representation of an individual's creditworthiness, calculated based on their credit history. Credit scores generally range from 300 to 850, with higher numbers indicating lower risk for lenders1.

Credit scores are typically categorized as follows:

• Excellent Credit: 800 and above
• Very Good Credit: 740-799
• Good Credit: 670-739
• Fair Credit: 580-669
• Poor Credit: Below 580

Source: FICO

Five main factors influence your credit score:

• Payment History (35%) - This is the most significant factor. It shows whether you've paid past credit accounts on time.
• Amounts Owed (30%) - This factor considers the amount you owe in relation to your available credit, also known as credit utilization rate.
• Length of Credit History (15%) - Generally, a longer credit history will increase your credit score.
• New Credit (10%) - This factor looks at how often you apply for and open new accounts.
• Credit Mix (10%) - This considers the different types of credit you have (e.g., credit cards, installment loans, mortgages)2.

To build credit, individuals can take the following steps:

• Pay bills on time: This can help build a positive payment history, the most significant factor influencing your score.
• Keep credit card balances low: Aim to keep your credit utilization rate below 30% to avoid negatively impacting your score.
• Don't close old credit cards: Longer credit history can contribute to a higher score, so it's often best to keep older accounts open, even if you're not using them.
• Diversify your credit mix: Having a mix of credit types can positively impact your score, but it's important to manage all credit responsibly.
• Limit hard inquiries: These occur when a lender checks your credit for a loan or credit line. Too many hard inquiries in a short period can lower your score3.

Common mistakes people make when trying to build credit include:

• Applying for too much new credit at once: This can lead to multiple hard inquiries, lowering your score.
• Running high balances: Even if you pay off your balance monthly, having high balances can negatively affect your credit utilization rate.
• Ignoring the importance of payment history: Late payments can significantly harm your score.
• Closing old credit accounts: This can shorten your credit history length and increase your credit utilization rate, both of which can lower your score4.

The role of credit scores in traditional mortgage applications

In the traditional mortgage application process, credit scores play a crucial role in shaping the terms and conditions of a mortgage. Lenders use it to gauge a borrower's likelihood to repay the loan on time. A high credit score suggests that the borrower is creditworthy and likely to make their mortgage payments on time, while a low credit score indicates a higher risk of default4.

The credit score directly influences key aspects of the mortgage, including:

• Approval or Denial: A low credit score can lead to a mortgage application being denied outright, while a high score increases the chances of approval.
• Interest Rate: Borrowers with high credit scores generally qualify for lower interest rates because they're deemed less risky. Conversely, lower scores often result in higher interest rates.
• Loan Amount: Higher credit scores can lead to approval for larger loan amounts, while lower scores may limit the size of the loan a borrower can receive.
• Loan Terms: Borrowers with high credit scores are more likely to qualify for mortgages with more favorable terms, such as smaller down payments or lower fees5.

The limitations of credit scores in mortgage applications

While credit scores have been the cornerstone of mortgage applications for years, they have their limitations. These traditional measures of financial stability don't always paint a full picture of an applicant's ability to repay a loan. For instance, they may not account for substantial savings or regular income from non-traditional sources. Moreover, the credit scoring system is inherently biased towards those with long-standing credit histories, systematically disadvantaging newcomers to the credit system4.

One group that experiences these limitations more acutely is foreign nationals. Despite having the financial capacity to invest in residential real estate, these individuals often face a complex and exclusionary mortgage process.

The exclusion of foreign nationals

Foreign nationals often struggle to secure a mortgage due to a lack of U.S. credit history. Traditional lenders heavily rely on credit scores, but these scores may not accurately reflect the financial stability of foreign nationals who have built credit in their home countries but are new to the U.S. credit system.

This exclusionary practice overlooks a significant market segment. Data from the National Association of Realtors reveals that foreign buyers purchased $54.4 billion worth of U.S. residential property between April 2020 and March 2021. This demonstrates the substantial demand and financial capability of foreign nationals in the U.S. residential real estate market.

Milo identified these limitations and saw an opportunity to provide more inclusive lending solutions. Milo specializes in offering mortgages to U.S. consumers, crypto asset holders, and foreign nationals who have been underserved by the traditional lending system. By adopting a more holistic approach to creditworthiness, Milo is able to serve these consumers more effectively and equitably.

By acknowledging and addressing the limitations of credit scores in mortgage applications, lenders can help create a more inclusive and fair financial landscape. It's a reminder that while credit scores can be helpful indicators of financial stability, they shouldn't be the sole determining factor for mortgage approval.

Conclusion

The mortgage industry has long relied on credit scores to assess risk, but this traditional measure doesn't always provide a complete picture of an individual's financial stability. This is particularly true for foreign nationals and others who have been underserved by the traditional lending system.

Milo recognizes these challenges and provides inclusive lending solutions that go beyond traditional credit scores. With a focus on U.S. consumers, crypto asset holders, and foreign nationals, Milo is pioneering a more equitable and inclusive approach to mortgage lending.

If you're interested in exploring your lending options with Milo, we encourage you to try out our calculators to see which program may work best for you. For a more personalized experience, feel free to contact our team at loans@milo.io. We're here to help you navigate the mortgage process and find a solution that fits your unique needs.

Sources:

1. Experian, "What Is a Good Credit Score?"
2. myFICO, "What's in my FICO Scores?"
3. Consumer Financial Protection Bureau, "Hard Inquiries Can Affect Your Credit Score"
4. Credit Karma, "4 Mistakes to Avoid When Building Credit"
5. Consumer Financial Protection Bureau, "How Do Lenders Use Credit Scores?

The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.