Whether you’re in the market for a new home, interested in purchasing a car, or heading to the store to grab groceries, there’s a good chance you’ll use some form of credit to complete the purchase.
Buying with credit means you are borrowing money which will later be paid back – but the amount owed and the time-frame required to pay it back depends on the type of credit it is. So knowing the type of credit you’re in the market for will help you understand how the arrangement might work.
A revolving credit account is one you can borrow from at any time, up to the limit set by the lender. This type of credit is paid off through making a minimum monthly payment (or more), based on your current balance. Credit cards and home equity lines of credit (HELOCs) are both examples of revolving credit accounts.
[Learn more about revolving credit.]
Credit cards allow you to borrow funds from a bank and pay back a percentage of what has been charged – or the entire amount – each month. If you opt to pay a percentage of your total amount due, you will be charged interest on the balance you carry forward. The amount you are able to charge – or your credit limit – as well as the interest rate you will pay, depends on a few factors:
- Credit score
Credit score requirements can vary from card to card. The cards that come with the best perks – like cash back or travel rewards – generally require a score in the “good to excellent” range (670/700-850). However, there are credit card options for those with bad credit as well.
- Credit history
Credit card companies will look at a variety of factors including payment history, outstanding debt, delinquencies, and credit utilization.
- Employment status and income
This serves as an indication of your ability to pay back debt and will help decide your credit limit.
Charge cards, on the other hand, are a bit different than traditional credit cards. In fact, they aren’t considered revolving because they require charges be paid off in full each month.
Home Equity Line of Credit
A HELOC allows you to borrow from the equity in your home if you’re approved (up to the credit limit established by the lender), and pay it back as you use it. In other words, it’s much like a credit card but using the equity you have in your home as collateral. This shouldn’t be confused with a home equity loan (or second mortgage) in which you’re given a lump sum and required to pay it back with fixed monthly payments over a predetermined amount of time.
Here are a few things the lender might consider:
- Available equity in your home
Many lenders require that you have at least 15-20% in equity. Equity is the amount your home is worth, less the amount you owe on your mortgage and is determined by an appraisal.
- Income and proof of employment
This will help determine your credit limit, if approved.
- Credit score.
Many lenders look for a score of 620 or higher. Getting approved with a credit score below 620 could be a challenge and may result in higher interest rates and other, less-favorable terms.
- Debt-to-income ratio.
Your debt-to-income ratio is calculated by adding up your monthly expenses and dividing that amount by your monthly income. To qualify for a HELOC, you’ll typically need a ratio of no more than 43%, although some lenders may accept a higher ratio.[Learn more about debt-to-income ratios and how to calculate yours.]
- Payment history
Lenders want to see a history of on-time payments.
Installment credit accounts are loans that are paid off over a set number of scheduled payments (or installments). Once the loan balance is paid off, the account is generally considered closed. Auto loans, mortgages, and personal loans are examples of installment credit accounts.
While mortgages and auto loans are tied to a very specific type of purchase, personal loans can be used for any purchase you don’t have the cash for, or to pay off debt. They are also generally not tied to any type of collateral – like a mortgage would be tied to your house and an auto loan would be tied to your car. However, if you’re searching for a lower interest rate, it is possible to get a secured personal loan tied to an asset.
When it comes to personal loans, lenders often look at your:
- Credit report
Just like any other type of loan, lenders will likely pay attention to your payment history, outstanding debts, credit utilization, delinquent accounts, bankruptcy, and the number of recent credit inquiries.
- Credit score
Many lenders look for a score of 600 or above. It is possible to get approved with a lower score, but that could result in a high interest rate and other less-favorable terms.[Dealing with a low credit score? Find out how to get a personal loan with bad credit.]
- Debt-to-income ratio
This can vary by lender, but typically this should be at or lower than 43%.
- Employment status and income
This will help determine how much loan you qualify for.[Shopping for a personal loan? Make sure you steer clear of these 7 mistakes.][Check out a few of the best personal loan options in Atlanta, San Antonio, Houston, Los Angeles, Sacramento, and San Diego.]
If you’ve heard any of the buzz around payday loans, it probably hasn’t been positive. That’s because payday loans are generally small, short-term loans (usually due when you receive your next paycheck) with very high interest rates. Because these terms make payday loans particularly hard to pay off, many states regulate how payday lenders operate, including the amount they can lend and the fees they can charge.
However, online payday lenders are subject to different regulations and could be charging even more to get a payday loan.
According to the Consumer Financial Protection Bureau, the cost of a payday loan is generally $15 for every $100 borrowed. This is a 400% interest rate – usually due within 2-4 weeks of borrowing the funds. If you are unable to pay back the loan at that time, some states allow payday lenders to “rollover” the loan to a later date – for an additional fee.
What lenders look for:
Payday loans don’t come with the same requirements as more traditional forms of credit. In fact, with no credit check and no credit history required, they can be far easier to get approved for.
Here’s what they generally will look for:
- An active checking account
Lenders often require you to provide a post-dated check with the amount you’re borrowing, plus fees. The lender will cash this check on the agreed-upon date (unless you pay beforehand).
- Proof of income
The expectation is you will pay off your loan when you receive the funds you are waiting on, such as a paycheck, Social Security, or pension check. Therefore, you must prove you have a source of income.
- A valid ID
In addition to a valid ID, you must be at least 18 years old to be approved for a payday loan.
A home is the largest purchase many people will make using credit and can have some of the strictest lending requirements as well. However, what lenders are looking for can depend on a few different factors – namely, the type of mortgage loan you apply for.
Let’s take a look at some of the 2020 loan requirement guidelines for a few of the most common types of loans.
Often backed by Fannie Mae and Freddie Mac, conventional loans are offered by private lenders as opposed to government agencies (like FHA and VA loans).
- Credit score: Minimum of 620
- Down payment: At least 3% (However, usually a down payment of less than 20% will require you pay private mortgage insurance (PMI).)
- Debt-to-income ratio: 45-50%
If you’re in the market for a home that would require a loan over the conventional conforming loan threshold, you will need a jumbo loan. This threshold can vary based on location, but for many areas of the country, the 2020 threshold is $510,400. Because this type of loan is riskier for the lender, the requirements are a bit more stringent.
- Credit score: Many lenders require a minimum of 700-720
- Down payment: 10-20% depending on the lender (Remember, usually a down payment of less than 20% will require you pay private mortgage insurance (PMI).)
- Debt-to-income ratio: This can vary based on your down payment, but many lenders require 40% or lower.
FHA loans are backed by the Federal Housing Administration and tend to have lower credit score and downpayment requirements. However, there are limits to FHA loan amounts based on county.
- Credit score: Minimum of 500
- Down payment: At least 3.5% with a credit score of 580 or above; at least 10% with a credit score of 500-579 (Note: All FHA loans require you carry mortgage insurance, regardless of the size of your down payment.)
- Debt-to-income ratio: 43-45%
VA home loans are available to active duty servicemembers, veterans, and eligible surviving spouses. While they are offered by private lenders, they are insured by the U.S. Department of Veterans Affairs and intended to provide favorable terms to those who qualify.
- Credit score: No minimum score required by the U.S. Department of Veterans Affairs, but private lenders may require a minimum of 580-620.
- Downpayment: $0
- Additional requirements: There are other service-related requirements you must meet to qualify for a VA loan.
Besides loan-specific requirements, lenders will likely look at a few key factors.
- Payment history
Just like other installment loans, lenders want to see that you consistently make on-time payments.
- Credit utilization
When it comes to credit utilization (the balance on your revolving credit accounts divided by the total credit available to you), you’ll look best to lenders if you use 30% or less of your available credit (generally, the lower the better).
[Learn more about credit utilization and how to calculate yours.]
- Delinquent accounts, accounts in collections, or a bankruptcy
If you have any of these items on your credit report, lenders could see you as a risky candidate for a loan.
Your income will help determine the size of the loan the lender is willing to offer.
- Debt-to-income ratio
The allowed debt-to-income ratio may vary depending on the type of loan you are looking for (see above), but this is an important factor for lenders to consider.
Buying a home with bad credit
Bad credit doesn’t necessarily mean owning a home is off the table. There are a few options available.
- Consider a rent-to-own home
Rent-to-own homes start with a rental agreement — which generally means the credit requirements are less stringent than a mortgage. You then have the option to buy the home later, although the exact terms will depend upon your agreement.
- Look for owner-financed homes
Owner-financed homes are exactly what the name implies — instead of paying a bank for a mortgage, you would pay the original owner of the home.
[Learn more about how purchasing an owner-financed home works.]
- Try an FHA loan
As you can see from the requirements listed above, FHA loans generally require a lower credit score than conventional loans. If your credit scores are within the range specified, and the home qualifies, this might be a good place to start.
Ready to get started on your home purchase? We have more info to help! Learn:
- The best cities to buy a house and the average home price in each state.
- Tips on choosing where to buy a house.
- How to buy a foreclosure.
- How long it takes to close on a house.
Need a new ride? There are a few ways to go about it, each of which may change what is needed to qualify. Let’s start by looking at the two main options: buying and leasing.
Buying a car
The credit score you need to purchase a car can depend on a variety of factors:
- The lender
Not only do lenders have different minimum credit score requirements, they aren’t all using the same credit scoring model. Some may be looking at your FICO score, while others will use your VantageScore, or a score specific to auto loans.
- The size of the loan
A larger loan means more financial responsibility which could lead to higher credit score requirements from the lender.
- The type of vehicle you’re trying to finance
Are you buying new or used? According to NerdWallet, the average credit score for a new car loan in 2019 was 715, while the average for a used car loan in 2019 was lower at 662.
Buying a car with bad credit
Bad credit doesn’t necessarily take you out of the car buying game. You’ll just have to explore a few alternative options.
- Go for used cars.
The average credit score needed to purchase a car tends to be lower for used cars than for new cars.
- Find a dealer that accepts bad credit.
Bad credit doesn’t necessarily mean a franchise car dealership won’t work with you, however, be prepared for a high interest rate. Another option is a bad credit car dealership, but this may come with additional risk.[Find a bad credit car dealership in Atlanta, Houston, or San Antonio and get tips on working with a dealership that accepts bad credit.][Tempted to purchase a car from a no-credit-check car dealership? Get all the facts first.]
- Try a credit union.
Credit unions sometimes have more lenient lending standards compared to big banks.
Looking for more information on buying a car? We have plenty of tips to help.
- Check out the ultimate car buying checklist, dealership edition, Craigslist edition, and online edition.
- Discover the hidden fees to look out for when buying a car.
- Take a look at the pros and cons of buying a car online and from a dealership.
- Find out how to know if the car you’re about to buy is a lemon.
Leasing a car
According to Experian’s State of the Automotive Market Q3 2019 report, only 23.5% of new car leases went to subprime and deep-subprime borrowers (those with a credit score of 501-600 and 300-500 respectively). That means a bad credit score won’t necessarily keep you from being able to lease a car, but it could certainly make it more challenging.
Other than credit score, lenders will likely consider factors similar to if you were going to buy a car, including:
- Payment history
- Delinquent accounts
- Credit utilization ratio
[Wondering what happens if you need to get out of your lease? Learn about your options.]
How does interest work?
In the context of credit, interest is the cost you incur for borrowing money — whether it’s a revolving credit account or an installment credit account. However, paying interest isn’t necessarily a given, particularly when it comes to revolving credit.
What does that mean exactly?
Say you charge $500 to your credit card and that amount shows up on your next bill. If you pay the full amount during your card’s grace period (the period of time between the end of the billing cycle and when the payment is due), you can avoid any interest charges. If you carry over a balance to the next billing cycle, you’ll pay interest on that amount and continue doing so every time you carry over your balance. (Note: Most credit cards have a grace period, but not all. Some will start charging interest from the time the purchase is made. Make sure you understand your terms before charging anything.)
When it comes to installment loans (or if you carry a balance on a revolving account), the amount you pay depends on the size of the loan or balance, the amount of time you take to pay off that amount, and the interest rate you’re given by the lender. Your credit score is a large determining factor for your interest rate.
Let’s take a look at approximately where rates stand based on credit score.
Auto loan rates by credit score
According to ValuePenguin, these are the average auto loan interest rates by credit score for 2020. However, these rates are subject to change and could vary based on other factors like length of loan (a shorter term could result in a lower interest rate).
- 500-589: 15.24%
- 590-619: 14.06%
- 620-659: 9.72%
- 660-689: 7.02%
- 690-719: 4.95%
- 720-850: 3.60%
$20,000 auto loan with a 60-month repayment period
- Lowest credit score monthly payment: $478.32
- Highest credit score monthly payment: $364.73
Mortgage loan rates by credit score
According to MyFICO, these are the average mortgage loan interest rates by credit score for 2020. (Note: These rates are for a $300,000, 30-year, fixed-rate mortgage. You can change the calculation settings here.)
- 620-639: 4.802%
- 640-659: 4.256%
- 660-679: 3.826%
- 680-699: 3.612%
- 700-759: 3.435%
- 760-850: 3.213%
$300,000 mortgage, 30-year fixed rate term
- Lowest credit score monthly payment: $1,574
- Highest credit score monthly payment: $1,300
Personal loan rates by credit score
According to ValuePenguin, these are the average personal loan interest rates by credit score.
- 300-639: 28.5-32%
- 640-679: 17.8-19.9%
- 680-719: 13.5-15.5%
- 720-850: 10.3-12.5%
$10,000, 60-month repayment period
- Lowest credit score monthly payment (32% interest rate): $335.93
- Highest credit score monthly payment (10.3% interest rate): $213.95
Interest vs. APR
Now interest rates aren’t the only number to pay attention to.
If you’ve ever looked at a credit card or loan statement, you’ve likely noticed a number called your Annual Percentage Rate (APR). This is the all-inclusive amount you’ll pay to borrow money – the interest rate PLUS the associated annual fees. So while your interest rate and APR are likely to be the same for a credit card, that might not be the case for a mortgage, auto loan, or personal loan.
The bottom line
The health of your credit plays a large part in whether you are approved for new credit as well as the amount you will pay for that credit over the course of your loan. If you’re considering making a financial move that requires new credit, now is the perfect time to check your credit report, dispute any errors you may find, and establish habits to get it in the best shape possible.
[Here’s the good news: Upturn can help you find and fix credit report errors for FREE. Sign up today!]