Ah, the dream of homeownership—a shining beacon on life's horizon. But for many, the hurdle…
There is a misconception that the number of homes you can buy will depend on your credit score. Up to a certain extent, it might be able to affect your purchase options drastically, but only if you are planning to buy a house through a mortgage.
Your credit score is the measure of the likelihood that you will default on a loan. No more, no less. Your credit report may account for the income you make but mostly to find your debt-to-income ratio, which is the amount of debt you have versus the income you receive. What will truly decide how much home you will buy is your budget, whether you have enough savings in the bank or take home a nice salary.
Regardless, there are indeed a lot of people who would probably want to know just what kind of home they can purchase with a 520 credit score, so here’s the deal. In this article, we’ll be honest with you about your home loan options, and we’ll also give some tips on how you can get a better credit score. Are you ready?
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The 2021 Real Estate Market
Due to the COVID-19 pandemic, the competition in the real estate market has gone to a level that hasn’t been seen for several years. CNN describes it as a market so “hot” that people are going way overboard to compete with other home buyers.
While the scenario is disturbingly reminiscent of the years leading to the last financial crisis, the situation cannot be any different. For one, there was no worldwide pandemic back in 2007 that convinced people to move out of the cities to seek more space out in the countryside. There are also more rigorous rules now in place to prevent a similar subprime mortgage disaster.
We mention this because as low credit scores serve as a red flag to mortgage lenders, so does this also serve as a warning to you, as a borrower, of your debt-readiness. And if you have a 520 credit score, the outlook is not as good as if you had at least 100 points more.
When more people with bad credit buy in an overpriced market, it is tantamount to a speeding train that’s headed to a brick wall.
There will still be loan options for this kind of credit score, no matter how few. Keeping in mind that if you approach mortgage brokers or advisors, they will want you to get you approved, and they will work to find ways. We’re just cautioning you to make the decision based on what you know of your finances.
520 Credit Score Home Loan Options
And so, without further ado, here are just some of the home loans you can try applying for with a 520 credit score.
The Federal Housing Administration loan is a government-backed mortgage that aims to keep options available for first-time homebuyers who are just starting to build their income and credit scores.
To qualify for an FHA loan, you need to have a credit score of at least 500, which, according to Experian, is the minimum credit score of 99% of American consumers.
If you have a credit score that falls from 500 to 579, you’ll be able to close a mortgage deal on the house even with just a 10% down payment. But if you have a credit score of 580 or higher, you’ll be allowed to make as low as a 3.5% down payment. Although this may sound like a better deal, note that this may not always be the best option.
Paying a 3.5% down payment means that you only have a 3.5% equity, so you’ll be making larger monthly payments and a more expensive interest charge over the life of your loan.
Mortgage Insurance Premium
Another thing that first-time homebuyers might not realize when they get an FHA loan is they have to pay for mortgage insurance, and the premiums keep coming until you have fully paid out your loan.
Paying for insurance seems reasonable enough. Lenders are just trying to protect themselves from a possible default. But as a borrower, it’s a lose-lose factor. The lower down payment you make, the higher insurance you have to pay for, and these payments you make will never count towards your equity. For this reason alone, you might want to consider avoiding FHA loans altogether and instead work on building a higher credit score.
Aside from FHA loans, another government-backed loan you can look into is insured by the U.S. Department of Agriculture. So regardless of your profession and regardless of your credit score, you can qualify for a USDA loan.
The main requirement of a USDA loan is to make sure you buy a house in a rural area. If you are not sure, you can check out their eligibility map.
Since more people flock to USDA loans due to the zero down payment benefit, there are also income restrictions. The USDA’s target is to promote the use of rural land and at the same time help low to middle-income families. So if you have a credit score in the 700s and have a higher income, someone with a 520 credit score and lower income will have more chances of qualifying.
The catch for USDA loans is you get absolutely no equity.
Although it doesn’t have minimum credit score requirements, mortgage lenders will still prefer that you get a credit score of 640 or better. With a 640 credit score, you can close a USDA loan faster because of automated underwriting. On the other hand, borrowers with credit scores less than 640 will have to go through manual underwriting to explain to lenders how they got into this credit situation.
If you’ve been through a bankruptcy, or you’re behind on your student loans, the USDA loan may be the most helpful loan type to go after.
Unfortunately, so far, those two loan options are the likeliest mortgages you can avail of with a 520 credit score.
You can’t qualify for conventional loans because the minimum credit score required for one is a score of 620. For VA loans, aside from being a service member, you’ll need to show a credit score of 640 or better.
The reality of the situation is, with a 520 credit score, you’ll most probably get more rejections than more approvals. And the more often you get a hard inquiry, the lower your credit score you can get.
How bad is a 520 credit score?
To explain why 520 is considered bad credit, the current national average for a FICO Score is actually 711. With this FICO Score, you can get approved for most home loans you apply for with the right income.
FICO Scores are the most common credit scores used by the three major credit bureaus: Experian, Equifax, and TransUnion. So once you express your intent to get a mortgage, lenders will want to take a look at your credit scores from all three institutions. Surprisingly, you can actually get different credit scores from each, but the one that lenders will use will be the middle score.
FICO classifies credit scores in these particular ranges:
- 300 to 579 is Poor;
- 580 to 669 is Fair;
- 670 to 739 is Good;
- 740 to 799 is Very Good;
- and 800 to 850 is Exceptional.
A 520 credit score is not the lowest FICO Score you can get, but it definitely is not the credit score you’ll want to be going in once you decide to buy a house.
How can I improve my credit score?
Chances are, if you have thought of buying a house despite having a 520 credit score, you are already at the point where you have no other option. If that is the case, we can recommend going for either of the mortgages we’ve mentioned (FHA loan or USDA loan) and working to improve your credit. Then, once you have a better credit score to snag a cheaper mortgage, you can try refinancing your loan.
The good news is, getting a mortgage is actually a good way of increasing your credit. It helps you show more experience in your credit report, and it adds more line items to your payment history.
On the other hand, if you can still afford to wait before making this big financial transaction, the best option is to wait until your credit score is in a better range.
In either case, there’s only one way to go, and that’s up!
Here are some good points to live by if you want to boost your credit score in a few months.
- Increase your income. Since credit scores are all about your credit history, they are all about your relationship with paying off debt. Often, people borrow money for the reason that they don’t have enough available funds. They might still be paying off other loans, or they don’t make enough income. If you want to improve your credit score, you need to work on paying down your debt. You can do this by hustling just a little more, maybe finding another income source that won’t require you to borrow more money. The more often you make payments, the more good points these add to your credit history.
- Live within your means. As we have mentioned, making a lower down payment means higher interest charges. It might seem cheap in the short term, but it’s going to cost you thousands of dollars in the long term. When you spend way less than the amount of money you earn, this can help your debt-to-income ratio and give you more money to stash away in the bank. It’s also an overall better way to avoid debt. In addition, this will mean that you’re not maxing out your credit cards which helps your credit utilization ratio.
- Finally, keep your eye on your credit. Although finding out that you have bad credit is a traumatizing experience, it might put you off from looking at your credit history again. But this is essential if you are to say goodbye to a poor FICO Score. If you didn’t already know, you are entitled to one free credit report every year that you can request here. There are also a lot of free resources online that can help you find out your credit without doing any harm to your score. Unfortunately, errors in credit scores are actually just getting more common. You don’t want to be stuck choosing between FHA or USDA just because someone put a different person’s late credit card payment on your credit report!