Whenever you think about mortgages, you probably imagine that you need a seriously exceptional credit…
There’s never a good time to find out that you have bad credit, but it can be exceedingly worse if you try to apply for a home loan. However, remember that it’s not the worst thing that can happen in your life.
Most people who are already planning to buy a house have basically started bracing themselves for the costs. And more than your credit score, you really should be worrying about the possible down payment and closing charges, as well as the succeeding monthly payments. Remember, getting approved for a home loan is just the first hoop you need to pass through to get to your dream house.
But what is, indeed, in a credit score? And what are your options when you have bad credit if any? These are all normal questions to ask as you start exploring the possibility of getting a mortgage. But, if you will be a first-time home buyer, we’re so glad to tell you that we can give you a lot of the answers you’re looking for.
How Bad is a 540 Credit Score
Before we get into which options you can look into, it’s important to understand your current situation.
One point that many people miss about credit scores is that this number is not only good for lenders to know. Yes, your credit score reflects the type of risk you carry as a borrower, which is why, more often than not, you might be turned down for a loan. However, since your credit score also says a lot about your more recent credit history, it can tell you a lot about your financial health. So, although it can tell lenders whether or not it is safe to loan you money, at the same time, it can also give you an idea if you are ready to take on another loan.
Whether we’re talking FICO or VantageScore, 540 does fall in the poor range of credit scoring. However, these two systems are the most often used by the biggest credit reporting bureaus to evaluate a borrower’s credit risk. One thing they agree on is that most lenders should definitely avoid scores below 600.
Depending on your reasons for getting a house, you can either delay making this big new purchase so that you can see about repairing your score, or you can go for some of the options we’ll be discussing later. It is worth considering that this decision can mean the difference between paying thousands more in dollars for a new house and saving that same amount that you can put towards home improvement, education, or other ways of investing in yourself.
Options for a 540-Credit Score Home Loan
The good news is, there definitely are options for borrowers who have credit scores starting at 540. Let’s take a look at them briefly below.
There are two government-backed loan options for this kind of credit score that you can turn to for help. The Federal Housing Administration guarantees the first one.
The FHA loan is a mortgage that’s really tailor-made for first-time home buyers. According to Experian, nearly all consumers actually have a credit score over 500, and this is why it’s great news that to qualify for an FHA loan, you really need to meet the minimum credit score of 500.
You will be asked for at least a 10% down payment to secure your mortgage at this credit score level. On the other hand, borrowers with credit scores of 580 or better can opt to make as little as a 3.5% down payment to close their loan.
It’s an excellent deal that ensures opportunities for most people, especially those who will absolutely need it. However, you do have to consider the repercussions of getting this kind of loan.
For one, since the government recognizes that they are taking on some risk guaranteeing a loan to borrowers with lower credit, you must pay for mortgage insurance premiums when you get an FHA loan. This is a kind of insurance that actually benefits the lender in case of a default. The charges will be included in your payments and will not count at all towards equity. Whether you’ve been paying for it for 5, 15, or 25 years will not matter. You’ll need to pay for this mortgage insurance until the day that you pay off the whole loan.
Although it is touted as a perk that the Federal Housing Administration allows borrowers to get up to 100% of their down payment from cash gifts or grants, keep in mind that this means paying when you don’t have any skin in the game more in interest much later. With an FHA loan, you can seek the help of some down payment assistance programs to close your loan, and these are essentially second mortgages with much higher interest rates that will just put you in even more debt.
While the existence of the FHA loan program is great as a means to solve the problem of housing in America, it does very much prey on the needs of borrowers with lower credit who might have nowhere else to turn to for help. Therefore, should you decide to buy a house with an FHA loan, we hope that you also consider working on your credit score to get later the option to refinance when you find yourself in a better situation.
Another option you might consider is getting a loan from the U.S. Department of Agriculture.
FHA loans may sound like a decent deal, but if you need to take on another loan to make the down payment, you’ll really dig a hole for yourself.
The great thing about USDA loans is that you don’t actually need to make a down payment to qualify for this type of loan. But it has the caveat that you can only get approved if you are borrowing for a house located in a USDA-recognized rural area, which can be tough for many people in need of mortgages.
Living in the countryside can paint a nice picture of self-sufficiency, but that’s only until you start realizing the costs of living far from where services can more readily be availed. As we have mentioned, having less skin in the game is not really good news. You might think that you are paying less for now, but you’ll be paying so much more once all this is over.
You can qualify for a USDA loan with a 540 credit score because this loan type does not actually ask for a minimum credit score. Instead, having a credit score of 640 is really just an edge because their system can more easily print out your credit history. But if you have a score that’s less than 640, this will mean getting manual underwriting, which is not really all that bad, as long as you can present documentation about your personal finances.
The USDA loan program is a great option for people out there who might prefer to make no down payment at all. It is also a great help for the country when you buy a home in a less developed area, where you’ll help boost the economy and lessen your carbon footprint overall. However, you have to take note of the weight of interest and what this can mean to your financial prospects. Most of us only have to get a mortgage once in our lives, so we better make this one chance count!
How to Improve Your Credit Score
Different people mean different circumstances.
Since you have a 540 credit score, this can mean one of a couple of things. First, you may be already in quite a lot of debt and are struggling to make payments. You might have even filed for bankruptcy in the past year, in which case, you may really want to think harder about a possible home purchase. Second, you might also just be starting in your financial journey and general career, which is why there are not a lot more line items in your credit report to give you a higher credit score.
Whatever it is that has pulled down your FICO Score, this is definitely a situation you can still turn around.
Here are just some of the things you may want to do in the next couple of months before requesting another credit report to find your status.
1 – Find more ways to hustle.
At the end of the day, it’s really all about the dough. If you don’t make enough money, you end up taking out loans. And the more loans that you get, the more expensive it is to live your life.
It’s a vicious cycle!
It’s time to get out of your rut. If you’ve been working in the same job position for years, maybe it’s time to ask for a raise. And if this is just not possible, maybe it’s time to look for other ways to earn more money. Maybe you have a hobby that you would rather spend your time doing. Then, you can think out of the box to make this pastime an income-generating opportunity. Then, the sky’s the limit!
2 – Become an authorized user.
One of the surefire ways to increase your credit score is to maintain your credit cards. This action serves several purposes. First, the longer your relationship is with financial institutions, the higher your credit score. And the more often you make on-time payments for debt, the more info you generate in your credit report.
However, it is one thing to consider that with a 540 credit score, it may be difficult to get a credit card in the first place (in case you don’t already have one), so instead, we recommend that you become an authorized user on some else’s account.
To do this, first, you have to find someone you really trust who has: 1. credit cards, and 2. a high FICO Score. Then, if they can trust you back enough, they might allow having you put down as an authorized user on their account. Normally, this means that you can basically use their credit card as long as you pay them back. But to boost your credit score, you will not even have to put a charge on their account.
When you become an authorized user on someone’s card, this person’s credit information will start appearing in your own credit history. And since they have a high FICO Score, some of this good will eventually start reflecting on your own score. The best part is, doing this is absolutely free!
Just as with compounding interest, time is on your side if you’re working to improve your credit score. Don’t miss out on this opportunity to take control of your situation. Your future self will thank you for it. Good luck!