The Federal Housing Administration (FHA) loan is often referred to as a first-time homebuyers' loan,…
Even if you have a 500 credit score, it’s not the end of the world. We promise!
In fact, since you are now reading this article, we’re happy to inform you that by the time you finish, you might have the answers to all those questions you haven’t even thought of asking yet.
We want to discuss with you what kind of mortgage loan options you can get with this kind of credit score, and we’re also going to give you some tips on what to do for your situation if you do go through with your mortgage plans sooner rather than later. There are actually many ways of doing this, and you have come to the best place to learn all about it. Read on!
Table of Contents
How Bad is 500 Credit
Credit scores are one of those things that don’t seem to matter until they start limiting your options in life. Unfortunately, sometimes this is the only time when we seem to start paying attention.
Strictly speaking, a FICO score of 500 is the absolute lowest you can go if you still want to have your pick of any house in America.
FICO Scores start at 350, and the highest FICO score you can get is a score of 850. Therefore, a 500 credit score is in the Poor range. Actually, any FICO Score less than 670 is considered bad credit, and 500 is way below this number. According to Experian, only 1% of consumers have a score lower than 500, and these are really exceptional cases. It may seem bleak, but you do need to face reality. A credit score of 500 is a very low score. Once you accept this truth, though, you can already start moving on to get out of this situation.
Answer the Why
First, you have to determine how you got here. Sometimes, age might be able to explain your circumstances. If you are much younger, this can be because you don’t have enough information in your credit report to generate a higher credit score. If this is the case, you will need to have the patience and the dedication to adhere to good credit habits. Make sure you aren’t overspending using your credit cards or missing due dates on your bills. These are definite ways to pull down credit scores. In due time, if you can watch your finances, you might find your credit score in a much higher range.
If you are indeed a lot older, though, and you have a FICO score of 500, we have a feeling you already know how you got to this point. Bad credit doesn’t just happen overnight. It can be a result of some major events; maybe you’ve gone through bankruptcy, or maybe you’re already drowning in all kinds of debt. We hear you!
It may take longer to rise from this situation, but there’s nowhere to go but up! If you’re in a hurry, there are some credit repair programs you can approach for professional help, or you can work it out on your own by scrutinizing your credit report.
In the meantime, there are still options for a credit score of 500.
Home Loans with 500 Credit Score
There are many different types of mortgages, but for a credit score of 500, you can have the pick of only two government-backed loans: USDA loans or FHA loans.
1 – USDA Loan
We will discuss the USDA loan program first because this loan type does not actually have minimum credit score requirements.
While the U.S. Department of Agriculture ensures this, you don’t have to be working in the farming industry to get approved. However, you do have to buy a house in a rural area to qualify for a mortgage. (If you want to know if the location you prefer is eligible, you can log on to this page and enter your details.)
The USDA basically wants to encourage more people to use rural land to nurture communities and boost smaller economies. To do this, they’re more than willing to accept borrowers with credit scores that are a little bit riskier; that’s why there is no minimum credit score.
If you have a credit score of 640 or higher, it’s a lot easier to qualify because the computer will be able to pull up your credit report much faster. But since your credit score is 500, you will have to go through manual underwriting. The lender will want to know you more because they want to assure themselves that you will actually have the capacity to pay. They’ll want to know why you have this credit score, if you’ve been paying your rent, or if you’ve made any late payments before.
Finally, you don’t have to pay money down for a USDA mortgage. It sounds really exciting if you can easily get your own house without making a deposit, right? Just remember, though, that zero down payment means you don’t have any skin in the game yet, so that you will be paying a lot more in interest eventually. This is also why USDA loans are considered a little riskier for lenders. Therefore, you will want to present an application that will show that you will be a responsible borrower.
2 – FHA Loan
Secondly, we have the basic type of mortgage that’s called an FHA loan. The Federal Housing Administration insures this one.
The USDA uses its attractive features to stimulate American rural areas; the FHA loan works to help first-time homebuyers get closer to homeownership. That’s why they have very low minimum credit score requirements. With a credit score of just 500, you can live in any house of your choice.
There are two downsides to this situation, however. First, since you only have a 500 FICO Score, you have to prepare at least 10% for your down payment and, because you’re getting an FHA loan, this one comes with nonnegotiable mortgage insurance. The fee may be a little lower compared to the mortgage insurance of other loan types, but if you’re getting a 20-year or 30-year loan, it’s a really big deal because you’ll pay it for the whole life of your loan. Second, it’s not even something that will work for you because it is only for the mortgage lender’s benefit. Remember, 500 is a very low credit score, so they want something to fall back on if you default.
Another thing you need to know about FHA loans is once you reach a credit score of 580, instead of paying 10% down, you will need to pay 3.5 percent. This can mean a lot, especially if you don’t have enough in savings yet.
For FHA loans, you can get the help of down payment assistance programs to raise money for your down payment, as well as accept gifted funds from family and friends who are willing to chip in for your new house. However, please note that they have to sign an official document to indicate that they will not be expecting compensation in the future.
When it comes right down to it, an FHA loan is a bad credit mortgage, but it is a big help for many Americans who need a bit more time to better their circumstances. It’s totally okay to get an FHA loan if it means getting you closer to your dreams. However, once you get that FHA mortgage, you won’t have to stick with it forever. Improving your credit can actually open you to a better opportunity which we’ll discuss in the last section.
Where to Go from Here
We cannot speak for all mortgage lenders, so it will be necessary for us to warn you that lenders will still have the final say about the minimum credit score. FHA loans are supposed to accept credit scores as low as 500, but you will still find many lenders who will not give you a home loan with this score.
Think of applying for a mortgage as telling your financial story because that’s what your credit report essentially is: the detailed history of your relationship with debt.
Since you have a bad credit score, this allows you to play the protagonist’s part in a character-driven story. But, again, there’s nowhere to go but up! You can either work on boosting your credit score or do nothing at all if you are already satisfied with a USDA or FHA loan.
We know about the main characters in stories, though, that things will continue to happen to them. Change is inevitable, and you can use this to your advantage when you eventually refinance your loan.
When you get a mortgage, as long as you can pay it on time monthly, you’ll eventually see your credit score rise. And once you get your score to a much higher level, you can actually work to convert it into another type of loan. This is what we mean when we talk about refinancing a loan.
In most cases, the best choice would be to go for conventional. But, maybe you already own your house 20 percent, and with this 20% home equity, you can actually say goodbye to mortgage insurance. It’s true! That’s already a lot of savings right there.
Right now, you may already qualify for an FHA, or you may be moving to a rural area anyway, so a USDA loan is a good option, but remember that you deserve better! You deserve more money in your pocket that you can put away into savings instead of paying mortgage lenders.
We know you can do it, and we’ll be right here whenever you need help!