The Federal Housing Administration (FHA) loan is often referred to as a first-time homebuyers' loan,…
Yes, even if you have a low credit score, you can still qualify for a home loan!
First, you will want to know how low, exactly, is low. As far as mortgages go, the higher your credit score, the better terms you can get. The first thing you will want to do as soon as you decide that you want to buy a house through a mortgage is to look at your credit history and find out your FICO Score.
There are more home loans out there than you might think. Mortgages really depend on the needs and preferences of the borrower, so even if two people got the same type of mortgage, they can still get completely different offers.
Today let’s learn about the credit score requirements of some of the most popular types of home loans. You may not know it now, but you probably already qualify for a home loan!
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Before we get into mortgages, though, let’s talk how low is low. If you have a bad credit score, what does this mean for your mortgage chances and options?
Your credit score is basically your risk quotient that mortgage lenders want to know because, let’s face it, home loans deal with a really big amount of money! You might have experienced loaning your friends or family some money before, and you probably only did because there was already trust built into the relationship.
Lenders, on the other hand, will usually not know anything about the people who want to borrow money off of them. They’ll want to know all about your work, how much money you make, and what loan experiences you’ve had in the past. These are pertinent information that help them decide just how much money you should be allowed to borrow, or if you should be trusted to borrow money in the first place.
Mortgages ask for minimum credit score requirements because this help them automatically filter out borrowers who have a higher likelihood of defaulting, the higher the loan amount gets.
The Fair Isaac Corporation computes the most common credit score used by credit reporting bureaus.
To get your FICO Score, the following information which can be found in your credit history will be taken into account in the following percentages: payment history (35%), amounts owed (30%), length of credit accounts (15%), variety of accounts (10%), and new credit accounts (10%).
With these numbers in mind, the following behavior and/or actions can help you get a higher FICO Score.
- Paying your bills in full and on time.
- Keeping your credit utilization ratio (how much you owe on each card) low.
- Avoiding opening new accounts in a short period of time.
- Trying out new types of loans.
- Keeping your oldest accounts.
How bad is bad credit?
As of this writing, the average FICO Score in America stands at 711, and as high as that may sound, this actually just falls within FICO’s good range. For FICO, credit scores 669 and below are already in the category of bad credit. But as you’ll later learn, even a FICO Score of 500 will actually let you qualify for a mortgage.
Home Loans with Low Credit Score
The basic type of mortgage is a government-backed loan guaranteed by the Federal Housing Administration.
Ultimately, FHA loans target first-time home buyers or low to middle income families who usually have bad credit and has nowhere else to go. The minimum credit score to qualify for an FHA loan is at only 500. But this is only on the FHA side. Realistically speaking there are more lenders out there who probably will not approve a mortgage for someone who only has 500, even for an FHA loan. It will be better to target a 580 credit score or better because this will allow you to put down as little as 3.5% of your home’s purchase price.
As good as these terms may sound, however, we recommend getting an FHA loan as your absolute last resort. Even if you already qualify for a loan with a 500 or 580 credit score, these can give some bottom-of-the-barrel deals that will make you end up paying so much more once all is said and done.
When you get an FHA loan, this also means paying for a mortgage insurance premium that does not fall off even if you are already the 90% owner of your house. This kind of insurance does not even benefit you at all and does not count towards equity. It will only protect the lender in the event that you default. If it will at all be possible, see about improving your credit score so you can get more options than just an FHA loan.
If FHA loans are government-backed, conventional loans are the opposite.
These are traditional mortgages that you can borrow from private lenders, so instead of paying a mortgage insurance premium to the government, you pay for private mortgage insurance (PMI) for your loan. The good thing about PMI though is it can fall off once you’ve gained 22% home equity. It’s automatic! And, if you have money enough to make a 20% down payment, you can skip PMI altogether. In general, mortgage lenders just believe that you have a lower chance of defaulting on your loan once you already have this much skin in the game.
However, the minimum credit score required to qualify for a conventional loan is much higher than for an FHA loan. Due to a 620 credit score requirement, this pushes a lot of people to go for FHA loans instead, which they can avail with as low as a 500 score. We highly suggest that if you go down a similar route, you use your FHA loan just as a stepping stone so you can eventually qualify for a conventional mortgage. It might not even be as hard since once you start paying your mortgage dutifully, your credit score will actually just keep increasing. Remember, a mortgage is a completely different kind of debt compared to a credit card and because you’ll also be paying for it monthly, it will be showing up a lot in your credit history.
The better loan for you is the one that will give you more savings. Most borrowers who go for FHA loans only do so because they didn’t have any other choice. This means a higher interest that will make a home purchase a lot more expensive as time passes. On the other hand, if you get a conventional loan and have a much higher score, you can: 1. borrow a higher loan amount, and 2. get a much better interest rate.
It might take time to improve your credit score, but it will absolutely be worth it!
Department of Veterans Affairs-insured mortgages are definitely hard to qualify for, because they only cater to a certain profession. But if you are indeed a service member, or qualified spouse of one, we’re so happy to say that you are eligible for one of the best loan options out there. That is also only if you have a credit score of 640 or higher.
A lot of borrowers prefer the VA loan program because it doesn’t even ask for a minimum down payment. Due to recent legislation that has removed previous loan caps, you can even borrow money for a million-dollar house! The interest rates of VA loans are some of the most sought-after in the industry. If you qualify for a VA loan, don’t you dare miss out on this opportunity!
All the mortgage loan types we’ve previously mentioned will let you qualify for a mortgage even if you have a FICO Score that’s considered as bad credit. As far as these home loans are concerned, there is a minimum credit score needed in order to get a mortgage.
There is however one type of mortgage that does not have minimum credit score requirements.
The irony of getting a high credit score really is, you have to keep yourself in debt. For this reason, a lot of people will actually even go out of their way just so they can avoid getting into debt. When you don’t have any debt, you also don’t generate a credit score. But what if it comes to the point that you really need to buy a house and you don’t have the upfront cash for payment?
Behind your credit score is an interesting story, but this is not often found in your credit report. When a mortgage lender takes a look at your credit report, the top of their priorities is to look at your credit score. They’ll want to know if you at least qualify for the mortgage you are applying for.
If you don’t have a credit score, this is when manual underwriting occurs. Remember, whether you are talking to a loan officer, a mortgage broker, or mortgage advisor, these people will want you to get approved for a loan, because then, they get their commission. When you don’t have a credit score, you can usually still be assisted through manual underwriting, which is a longer process of checking your history to judge if you are a risky borrower. You’ll be asked for lots of documentation, maybe receipts of your previous rent payments, utility payments, or similar. And this is usually what you’ll go through if you get interested in the next loan type we’ll mention if you have a poor credit score.
As the name implies, this is insured by the U.S. Department of Agriculture.
USDA loans don’t actually ask for a minimum credit score, so even if you have bad credit that won’t even qualify you for 3.5% down payment for an FHA loan, you can still have a chance to get a mortgage. Honestly speaking however, because we don’t want to lead you on, it will still be pretty hard to qualify for a USDA loan with a lower credit score. Mortgage lenders will want to know the story behind your poor credit that’s why you might get into manual underwriting with a less than 640 credit score. If they don’t see enough reasonable circumstances in your credit history that justifies getting bad credit, you might still not get the loan.
Other points to think about USDA loans are:
- you need to be buying a house in a USDA-recognized rural area in order to be qualified;
- and if you do get a USDA loan, you are not required to make a down payment.
A USDA loan is really a toss-up of some of the pros and cons of the other loan options we’ve mentioned. On the one hand, it may be possible for you to get a loan with a 500 credit score and make no down payment at all, but there’s a really big compromise in making sure to live in a rural area, because since you’re getting a government-backed mortgage, you have to make sure that you’re buying a house that will become your primary residence.
At the end of the day, your credit score is really just a number. We do recommend you improve your credit score so that you can get more options instead of getting stuck with a bad credit mortgage. But if you’re thinking of your credit score too much that it stresses you out, you might be missing out on life’s finer moments.
We wish you luck in your mortgage journey, and if you ever need help, you know where to reach us!