The Federal Housing Administration (FHA) loan is often referred to as a first-time homebuyers' loan,…
Any fantasy about dream houses or the perfect seaside home is usually accompanied by the realization that it’s time to take a look at your latest credit report.
Many people often worry if they qualify for a mortgage, especially if they have what is usually referred to as bad credit. However important credit scores are to your mortgage application, there is indeed a technical definition for this. It depends on where you stand on the FICO Score scale.
If you are one of these people, there are two things that we would like you to know. First, you can definitely still buy a house with bad credit. In fact, there are a lot of government-backed loans that were created primarily to provide these options. Second, becoming eligible due to your credit score is really only half the battle. You’ll also want to ensure that you have enough available funds to make the down payment and pay the mortgage’s closing costs.
The questions we would like you to focus on most, as a borrower, are the following:
- Which home loan with bad credit would best suit your needs?
- How much money should you prepare in order to close the deal?
- Are you willing to put in the time to improve your credit score?
Bad Credit Scores
So, let’s talk about what makes a credit score bad.
Since FICO scores are usually what the bureaus and the mortgage lenders refer to for loan applications, we will be using the Fair Isaac Corporation’s definition of a bad credit score.
Essentially, if your FICO score is below 670, this is already considered bad, but there are nuances. Scores from 580 to 669 are Fair scores, while scores from 300 to 579 are considered Poor. That last part makes sense because FICO Scores begin at 300. If you do have a 300 score, most likely, you’ll already know what led you to this situation. With this kind of credit rating, you’d also be a member of a very small club, because according to Experian, only 1% of people have a FICO score less than 500.
The stickier your situation, the harder it may be to get mortgage approval. However, it can really just be a matter of getting the determination to chase all the available options.
Let’s look at the bigger picture.
Minimum Credit Score for Home Loan with Bad Credit Score
The right to housing is a human right, and despite what your credit report may say, this cannot be taken away from you.
The government has made available nontraditional home loan options that different agencies guarantee to ensure that Americans get their own house with bad credit.
1 – VA Loan
The most in-demand government-backed loan at the moment is the one insured by the Department of Veterans Affairs. Due to recently passed legislation that took effect in January of the previous year, our veterans and their eligible spouses are now allowed to borrow a lot more money via the VA loan.
Needless to say, VA loans are exclusive to our service members. However, if you are lucky enough to have this as a job benefit, we highly recommend you apply for this. This will be your best option among all the bad credit home loans you will find out there, especially if you don’t want to be limited to where you want to buy a house.
Even if you have had foreclosures or bankruptcies in the past, you’d still be welcome to apply for a VA loan. There’s really no prescribed minimum credit score for you to apply, but you might find that there are mortgage lenders who have their own overlays, including a lower debt-to-income ratio or stable employment. In general, if you have a credit score of at least 640, which is still below the Good credit score range, you might have an easier time applying due to automated underwriting. But if your score is below this number, that’s when you’ll want to prepare some more financial documents that will prove your ability to repay.
For a VA loan, you are not required to make any down payment, and you also don’t have to worry about mortgage insurance. There are also people at the VA you can call for assistance if you start having trouble making monthly payments.
2 – USDA Loan
Now, if you can’t qualify for VA due to its exclusivity, you might want to consider moving to a rural part of the country so you can qualify for a mortgage guaranteed by the U.S. Department of Agriculture.
USDA loans can be beneficial for borrowers with bad credit. Besides aiming to promote the use of land in the less populated areas of the U.S., it also aims to assist low-to-middle-income families. You really don’t have to worry even if you have poor credit because lenders will review your application according to the circumstances that gave you a lower credit score. Like VA loans, if you have a 640 or higher credit score, you can get automated underwriting. If you have lower than this number, prepare for a lengthier application. As long as they see that you’ll be capable of making a monthly payment, you’ll have a fair shot at qualifying for this type of mortgage.
The USDA loan program is also another zero-down payment mortgage. There’s no need to worry about expensive closing costs, but you’ll want to make sure that your location will truly qualify by entering your details on this USDA page.
3 – FHA Loan
The last government-insured loan you might want to look into is called the FHA loan.
As you may have guessed, this mortgage is backed by the Federal Housing Administration. While it may not have the job history requirements or location requirements of the VA loan and USDA loan, respectively, the FHA loan does have minimum credit score requirements. To qualify for an FHA loan, you must have a credit score of at least 500. With a 500 FICO Score, you’ll have to prepare as much as 10% money down for your dream home, but if you have a credit score of at least 580, you can put as little as 3.5% for a down payment.
FHA loans are really best as stepping stones for more traditional loans. This is because, with an FHA loan, you have to think about mortgage insurance, which stays for the life of the loan. Since FHA loans only require at least 10% or 3.5% down payment, this puts you at less than 20% home equity. Unfortunately, there really is just no way to remove insurance from your monthly charges unless you decide to refinance your mortgage.
The common denominator among these three government-backed loans is that you have to use the house you’re buying as your primary residence for at least one year. And since you can’t have more than one primary residence, you can only have one government mortgage loan at any given time.
If you are buying another house, though, because you mean to invest, or you want a place to escape during winter, there is a different type of loan that may suit this particular need.
Conventional loans are the exact opposite of government loans. They might be a little stricter regarding minimum credit score requirements, but it is still possible to qualify for a conventional loan despite lower credit scores. The lowest your score can get that will still enable you to qualify is a 620 credit score. The higher you can get it, the better. The larger the down payment you can make, the cheaper your mortgage can also get.
For conventional loans, the charge you pay that protects the lender is called private mortgage insurance (PMI). A significant edge that conventional loans have over FHA loans is you can skip PMI outright if you make a large enough down payment. You will need to have as much as 20% in cash to avoid paying PMI, but if it simply isn’t possible, you can still relax by knowing that once you reach at least 22% home equity, PMI goes away on its own.
Fannie Mae and Freddie Mac are the government institutions that define the loan limits for these traditional loans. These limits change a lot, so it’s better to check the latest announcement for your own information. If you can qualify for a conventional loan, you might also be allowed to borrow a lot more money than FHA loans or USDA loans, according to your credit score and the loan limit in your area. And the best part, you can even pay as little as 3% down.
Improving Your Credit
With all of this information now in the back of your mind, it’s time to answer our last question. Do you actually have the time to work on your credit? And are you willing?
Real estate purchases don’t really happen overnight. Even if you are absolutely in a rush, there are just many logistical areas you have to plan for, after all, it means moving your life! But the actions you do need to take in order to increase your credit take a lot more time than the period needed to shop around for a house. Sometimes, it can take months. If you’re particularly unlucky, it can even take a whole year, depending on your scenario.
Clearly, the best option to choose, though, is the conventional mortgage route. Unfortunately, a 620 credit score can be a little steep for a lot of borrowers. Furthermore, it’s also more ideal if you get money for at least a 20% down payment, which usually means tens of thousands of dollars.
Whatever you decide, what’s important is you are buying a house that you absolutely need, and if you can pay your dues every month until the end of your mortgage loan, it will be a job well done.
Lenders consider several factors before approving you for a certain loan program. It’s not enough to check your credit or save money for all the costs. You also need to watch your existing debts and ensure that you have a steady flow of income. A mortgage with bad credit is only useful if you can actually pay for it all the way through!
If you still find the whole mortgage application process a bit daunting, or if you want to save yourself all the anxiety and stress that this challenge entails, we recommend that you ask for the help of a mortgage advisor. Sometimes called mortgage brokers, these are experts who will already have all sorts of contacts in the home loan industry. They can help you shop around for home loans without you having to speak to anybody else. They’ll also have access to the best interest rates and loan options so you won’t have to be limited by your credit score.
Remember, you’re not the first person to have ever dreaded seeing their own credit report. Yet, thousands of people have acquired new homes despite this pandemic. Will you be the next new homeowner?