Ah, the dream of homeownership—a shining beacon on life's horizon. But for many, the hurdle…
When home prices are rising, it might be harder to find a house in your price range than qualify for a mortgage with reasonable interest rates.
Recently, we’ve been seeing the lowest mortgage rates in a long time due to the impact of the COVID-19 pandemic on the economy, so more people have been motivated to acquire mortgages, resulting in a mad increase in home prices.
And the first thing you do once you decide to get a mortgage is to check your credit report. But what do you do if you find out that you have a low credit score? For example, is it possible to qualify for a mortgage if you have a 550 credit score? What about a 500 credit score?
Today, we’re here to calm your fears and anxieties. But, first, you must understand that you still have options despite having a bad credit score.
What are these options, and what do you do to get approved for a mortgage?
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Options for Home Mortgage with Low Credit Score
Usually, home loans require a minimum credit score for you to apply. But there is one government-backed loan that seeks out people who have particularly been affected by unfair circumstances so that they can get a shot at homeownership. This is the USDA loan.
Insured by the U.S. Department of Agriculture, the USDA loan will help you buy a house as long as this house is located in a rural area. You don’t have to be a farmer, nor will you have to use this home for a commercial purpose. As a matter of fact, you are required to only use this house as your primary residence for at least one year. Needless to say, you can only get one USDA loan at a time.
To be of further help to citizens with less than ideal credit scores, the USDA loan also does not ask for a minimum down payment. You can even make zero down payment if you really don’t have the capacity to raise funds. With this in mind, certain income limits will disqualify you from getting this type of loan. During the application, the overall household income will be taken into account, and you will want to know your particular state’s income average.
If you want to inquire into your eligibility quickly, you can visit this page to enter your information.
Another important loan type that provides valuable help to borrowers with low credit is the FHA loan. As its name implies, this one is insured by the Federal Housing Administration.
FHA loans exist because, according to Experian, 99% of consumers have a FICO Score of at least 500. Since FHA loans require a minimum credit score of just 500, this means that almost everyone can qualify for a mortgage under the FHA loan program.
It does have its pros and cons, however. One of the benefits is making as little as a 3.5% down payment if you can get your score up to at least 580. This is actually quite doable when you realize that a 500 credit score really sometimes comes from extreme circumstances. However, if you can only keep it below 580, you’ll have to deposit at least a 10% down payment. Now, if that 10 percent is really too expensive for you, the FHA loan makes it easier for people to buy homes because they allow you to raise your down payment funds from other sources. For example, friends or family might want to gift you seed money for this purchase, or you might want to approach down payment assistance programs if they are available in your state.
Unfortunately, if you get an FHA loan, it comes with nonnegotiable mortgage insurance you have to pay for over the life of the loan. Even if you always pay on time and you’ve been paying quite a long time, there’s just no taking it out of your monthly payments. This is insurance meant for the mortgage lender as well. This doesn’t benefit you as a borrower at all. Eventually, some people stop paying for mortgage insurance to refinance their mortgage into another loan that will no longer ask for insurance. However, you’ll have to weigh in your situation if this will offer you any savings since refinancing means getting another mortgage, which comes with its own closing costs.
Better Options for Bad Credit
There are technically other choices you may want to look into in this kind of scenario.
By definition, a bad credit score is any credit score below 670. That’s according to the Fair Isaac Corporation. So these next mortgage options we’ll talk about don’t really ask for good credit scores (above 670) for you to qualify, but they do ask for more stringent and exclusive requirements than the two government-backed loans we’ve already mentioned.
See if any of these two may apply to you.
Conventional loans are your traditional loans regulated by Fannie Mae and Freddie Mac. To qualify for a conventional loan, you only need a minimum credit score of 620. Take note that this is a very loose requirement because mortgage lenders define their own terms at the end of the day. There are definitely many lenders out there who will accept a 620 credit score provided you score better on other factors, like debt-to-income or ability-to-repay.
Strictly speaking, conventional loans are not insured by the government; instead, they have private backers. You have to pay for what’s called private mortgage insurance (PMI). This works the same way as the mortgage insurance you have to pay for FHA loans but with one main difference. While FHA mortgage insurance stays for the whole life of the loan, PMI only needs to be paid up to a certain point. You will not even be charged for PMI at all if you can make a down payment of at least 20 percent.
The general rule for conventional loans is the higher your credit score, the better terms you can get. As a result, you might be approved for a higher loan amount or better interest rates. You can even use a conventional loan for an investment home or vacation home, unlike government-insured loans that require you to use the home as a primary residence. You can have as many conventional loans as your income will allow you to have.
As we’ve mentioned, many people who get FHA usually switch to a different type of loan after a certain period of time. This is because if you’re able to keep paying your bills on time after acquiring an FHA loan, you’ll eventually improve your credit score. Since 620 is not too far from 580, most borrowers are usually able to achieve this, so after an FHA loan, the logical refinance option is a conventional mortgage.
The Department of Veterans Affairs also insures a home loan meant for our service members. And even if you have bad credit, this wouldn’t really be a problem as long as you have previously served in the military. However, there will be mortgage lenders who will prefer applicants with a 640 credit score or higher. So if you have this credit score, you might be approved faster. On the other hand, if you have a lower credit score, your application may have to be manually underwritten so that it may take longer.
It’s absolutely worth it to get this kind of loan. Like the USDA loan, you don’t have to make a down payment for a VA loan. But, unlike USDA loans, you can buy a house anywhere in the country, and you may even be approved for a higher loan amount than you might expect due to recently passed legislation.
With VA loans, mortgage lenders are also usually more willing to give favorable mortgage rates. This loan type currently has the best interest rate in the market. If you are lucky enough to have this among your loan options, there really is no more question of which mortgage you should get.
The Choice is Up to You
These days, poor credit is really no longer a hurdle to get a loan.
We would highly advise against applying for these, but there are even subprime loans you can still qualify for if there really is no other way for you to go. You’ve probably heard of these bad credit mortgage loans before, especially from a decade ago, because they were a big cause of the last financial crisis. And they really should be a ‘break-glass-in-case-of-fire’ option due to the really high interest rates they impose on the loans.
At this point, you are really faced with two options: either go for USDA or FHA loans or work on improving your credit score so that you may either qualify for conventional or VA (just in case you are eligible).
Remember, no matter how relaxed the minimum credit score requirements are for some types of loans, the decision will ultimately rest on the lender. So you might apply for an FHA loan with a credit score of 500 and still leave empty-handed from one lender. But don’t get yourself down. You can always try your luck with another lender, and they’re really are more out there.
One beneficial thing you may also want to consider is getting the services of a mortgage broker. Now, brokers typically charge a fee of about 1% of the loan amount. This might be paid by either the lender or the borrower at closing. The choice really is yours. If you feel that this 1% fee can make up for all the stress and worry that the mortgage chase will put you under, it is more than worth it.
It’s also good to remember that your credit score is not the only factor lenders consider when you apply for a loan at the end of the day. For example, your debt-to-income ratio will also become very significant when you’re buying a house through a mortgage loan. So, yes, you do need to improve your credit because it will help you save some money, but if you cannot make a larger down payment anyway, you’ll basically be paying for a more expensive mortgage.
Know that there are lots of people you can talk to about this. There are probably family, friends, or acquaintances of yours who have been through their own mortgage journeys. We are also always here whenever you need help!