Whatever your got-to home buying strategy is—a cash buyer or home loan diva—we've put together…
One of the most significant decisions we’ll make in life is renting or buying a house.
It can be cheaper to rent in many places in the country than to own a home. In a study by LendingTree, they found that the average difference in cost can climb up to $606 monthly. But homes can be very personal for many people, and this means that homeownership has an unquantifiable value compared to renting.
Of course, once you’ve paid off your mortgage, you are left with an investment. This is something that you can never earn no matter how much cheaper renting can become.
If you don’t have the money to buy a house upfront, there is usually only one answer: getting a home loan. So how exactly does one qualify for a mortgage? Will a 550 credit score be enough, and what will your options be at this point?
Let’s answer these and more in the sections below.
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Factors Affecting Eligibility
With many mortgage lenders in the country, we can ascertain that each one will have unique customer preferences and requirements. After all, the mortgage business deals with incredible sums of money.
There are requirements they’ll ask for that you can have some degree of control over. In the weeks or months leading to your mortgage application, the following are the factors you may want to focus on to increase the chances you’ll get approved for a loan.
1 – Assets
Although you’re borrowing money to pay for a home purchase, mortgages will usually still require a down payment. When this is not the case, it is still more practical to pay than to have zero home equity from the start. A larger down payment means less to pay in interest. It can also mean skipping mortgage insurance, especially if you’re getting a traditional home loan.
With that in mind, it will matter to your application how much you have saved to this point. In addition, mortgage lenders will want to know how ready you can make a down payment and pay the subsequent amortization. Sometimes, the amount you have in reserve must be equivalent to the number of months they want to be assured of payment.
Remember, as long as you haven’t fully paid off your mortgage, the house remains a liability. You’ll be tying a lot of your liquidity to this new home, so you’ll want to have other assets that will help you earn income in the meantime.
2 – Employment
Your salary is also of great importance to your mortgage chances. Regardless of how much money you have in the bank, the mortgage lender will expect the borrower to have a monthly income that will provide for payments.
A history of at least two years’ steady employment is strongly recommended.
Nowadays, lenders give a lot of weight to borrowers’ income stability due to the uncertainties of the pandemic. And this only makes sense. Of course, we do not know what can happen tomorrow. But, as a borrower, you also do not want to be saddled with this kind of debt if you cannot be sure of the salary you’ll receive in a year or two.
If you want to impress mortgage lenders, a job to expect growth will boost your application. In addition, it gives lenders more confidence to lend to someone who has a higher chance of staying in a job and even getting a bump in salary.
3 – Debt-to-Income Ratio
Your debt-to-income (DTI) ratio is a percentage that represents the amount of money taken from your monthly income to repay your combined debts.
The ideal DTI ratio will vary depending on the mortgage lender and the loan type. However, we suggest keeping your DTI ratio below 40 percent, especially right before a mortgage application. This will give you enough room to include amortization for a mortgage.
It may take an entirely separate article to discuss how to find your own DTI ratio, but there is something you can keep in mind if you want to get as low a percentage as possible. First, do your best to pay off whatever debts you can, and then work on increasing your income before you get a home loan. We recommend doing at least one of those two actions, but doing both will provide the most optimal results.
4 – Credit Score
Last but definitely not least, mortgages have minimum credit score requirements. Credit scores help lenders easily determine if borrowers have a higher chance of repaying a mortgage loan responsibly.
A lower credit score gives you a limited set of options, while a higher credit score will help you become eligible for almost any type of loan.
Your credit report will contain your credit history. The items in this report give an overview of your finances and accounts. Your credit history will be graded according to the following categories: payment history, the amount owed, length of credit history, credit variety, and new credit accounts. Of these six, the most vital category that most affects your credit score is payment history. If you’ve made multiple late payments for different accounts, this can be of great concern to mortgage lenders.
Aside from helping you get approved or making you ineligible for a home loan, your credit score also influences how much money you can borrow and how high or low the interest rate can become. This is true not just for mortgages but also for personal loans, auto loans, and other kinds of debts. After all, a credit score determines what type of mortgage will be approved for you.
Where You Stand
If you have a 550 credit score, this means you cannot get approved for the traditional type of loan.
FICO Scores range from 300 to 850, where 300 is the lowest and 850 is the highest FICO Score. A 550 FICO Score is considered a bad credit score because the excellent range of FICO Scores begins at 670. Sadly, you are more than a hundred points below.
What does this mean for your mortgage chances?
On the upside, government-backed mortgages are designed precisely to help out borrowers with credit scores like yours. There was a time when only those with excellent credit were approved for home loans. A 550 credit score means you are a risky borrower for mortgage lenders, but luckily, today, there are loan options for your situation.
Home Loan with Credit Score of 550
As we’ve mentioned, you’ll only be able to qualify for government-backed loans at this point.
Below is a brief list of the government-insured mortgages that will accommodate you according to your needs and background. See if one of these suits your profile.
The Federal Housing Administration loan or FHA loan is a mortgage haven for lower credit applicants. With this government-backed loan, you can qualify for a mortgage with a credit score as low as 500.
However, to get an FHA loan with this credit score, you’ll need to prepare a 10% down payment based on your home’s purchase price. If you can get your credit score to at least 580, you can get the opportunity to pay as low as a 3.5% down payment. Note that a less than 10% deposit means paying for mortgage insurance for the life of the loan. With a 10% down payment, you only have to pay for mortgage insurance for eleven years.
If you cannot meet the down payment requirement, mortgage insurance can significantly expensive FHA loans. However, should you find yourself in this scenario, you can use FHA loans as a mere stepping stone so that you can later apply for conventional loans.
Conventional loans are the more traditional loan type, and while it has private mortgage insurance, if you can have 20% home equity right off the bat, there’s no more need to pay for this charge. Once you have spent enough on your mortgage and drastically improved your credit score, you can see about refinancing your FHA loan into a conventional loan.
If you are willing to move out of the more populated cities, you might want to look into applying for the rural development loan, known as the USDA loan.
This is a type of loan guaranteed by the U.S. Department of Agriculture, and there are two ways you can avail of this: either directly through the USDA or through a private lender who offers USDA loans. We mention this because you have a 550 credit score; you might have a more challenging time applying for a USDA loan if you go through the second route. But, on the other hand, if you use for USDA directly through the agency, you might have a better chance of getting approved for the loan.
There is no minimum credit score requirement, but mortgage lenders usually want a 640 credit score. If your credit score is below this number, your application will undergo a manual review. So if you’re going to get this home loan because of its zero-down payment feature, you’ll want to prepare as many proofs of your financial history and payments to debts as you can as you anticipate the manual underwriting.
Finally, we have one type of government-backed loan that combines the best features of the FHA loan and the USDA loan programs. But this one is only available for a select group of people.
The Department of Veterans Affairs also insures mortgage loans for active-duty officers, veterans, and the surviving spouses of veterans who have passed. Again, it’s a well-deserved job benefit, and the VA sweetens this deal by backing 25% of the loan so that the mortgage lender gets motivated to give the borrower only the best features they can offer.
With a VA loan, you can buy a house anywhere in America and at the same time move in without having to make a down payment. Of course, you’ll still have to deal with closing costs, but it’s a preferable option to having to pay 10% like with an FHA loan.
Many lenders indeed do their best to approve as many qualified VA loan borrowers as they can. Be informed, though, that even if you are eligible, you may be turned down for a VA loan due to a 550 credit score. Although the Department has not set a minimum credit score for this loan, this decision ultimately rests with the lender.
Still, it’s worth a shot so you can see if you can avail the best mortgage rates on the market.
Where to Go From Here
It’s a very hot market right now to be on the fence about buying a home. You’re either in or out.
Since you have a 550 credit score, it may not be the ideal time for you to be wading in these waters. Lower credit scores mean you don’t have a lot of negotiating power.
There are two scenarios for you.
If you still have time to think about it, we highly suggest boosting your credit score before talking to several mortgage lenders. Everyone is entitled to a free credit report once a year through the Annual Credit Report, and there are also online tools you can use to monitor your credit score. If you are willing to go down another road, you can even look into credit repair. Just remember that this means an added cost. It will always be much cheaper to keep healthy and responsible financial habits.
If you have no choice but to get a home soon, instead of shopping for a mortgage lender yourself, you can entrust this task to a worthy mortgage broker. This way, instead of talking to lenders one by one and by doing so, knocking points off your credit score, you only get a hard inquiry once. Your mortgage broker will do the rest until you get a loan match.
There are thousands of mortgage companies in the country. And if there is a will, there is a way. See if you can talk to other people you trust to pick up on recommendations if they’ve already applied for their mortgage.