Ah, the dream of homeownership—a shining beacon on life's horizon. But for many, the hurdle…
If you understand how interest rates work, you probably already know how important it is not to get a mortgage when you have bad credit, especially if you’re looking to pay for it for up to thirty years.
There are many types of home loans in the market, and the good news is, you can still qualify for a mortgage even if you get a credit score as low as 500. Unfortunately, this won’t necessarily mean that you’re already out of the woods. If you have a low credit score, this might mean that the mortgage lender will give you more expensive mortgage rates, or you might only be allowed to borrow a lower loan amount. Whatever the case, you have to make sure that you are one step ahead of lenders, and one way of doing this is improving your credit score even before you start applying for a mortgage.
In this article, we’re going to talk all about home loans and the kind of credit score you need to qualify for a mortgage. We’re also going to give you a crash course on how to improve your credit so that you can raise it by at least 100 points by the time lenders take a look at your credit report.
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How Bad are Bad Credit Scores?
It might sound surprising, but you don’t actually need an exceptional FICO Score to meet most home loans’ minimum credit score requirements. In fact, there is one government-backed loan that doesn’t even ask for a minimum credit score. So, if you don’t believe us, the following are just some of the mortgages you can apply for even if you have bad credit, which, according to the FICO scoring model, is any credit score that’s lower than 670.
Low Credit Score Home Loan
If you were interested in the type of mortgage we mentioned that doesn’t require a minimum credit score, you might want to buy a house in a location that the U.S. Department of Agriculture recognizes as a rural area.
What you’ll be getting is called a USDA loan, and though there are no credit score requirements, you will have to go through a manual underwriting process if you have a credit score of 639 and below.
If you are a first-time homebuyer, there is also a government-backed loan that’s meant specifically for you.
The Federal Housing Administration guarantees mortgages that ask for only a minimum credit score of 500. With this kind of score, you’ll be asked to make a 10% down payment, but if you only have enough money to make a low down payment, you can be allowed to pay for just 3.5% as long as you have at least 580 credit score. For this reason, FHA loans are indeed quite popular, especially since, according to Experian, 99% of borrowers have a credit score of higher than 500. That’s almost everyone!
Now let’s say that you don’t really want to move to the middle of nowhere to qualify for a USDA loan and what you’re really buying is a secondary home, which is not allowed if you want to qualify for an FHA loan. So what you can do is to apply for what’s called a conventional loan, which is the complete opposite of a government-backed mortgage.
Conventional loans ask for at least 620 minimum credit score, but note that there are definitely mortgage lenders out there who will not approve applications with less than 650. So although the credit score needed is a lot higher than what’s asked for by FHA loans, you can still make as little as a 3% down payment when you’re buying a house that might serve as an investment home or your cabin for the weekends.
However, take note that conventional loans paid with a less than 20% down payment ask for private mortgage insurance, which is a fee you pay to assure the bank on the off chance that you default. Many people prefer to skip this, which is why it’s a great idea to prepare at least 20% of the home’s purchase price if you qualify for a conventional mortgage.
Finally, and we’re just mentioning this because the benefits are not to be missed, especially if you are eligible; there are VA loans that the Department of Veterans Affairs insure.
Of late, the VA loan program is having its heyday due to the Blue Water Navy Vietnam Veterans Act of 2019, which took effect last year. The popularity of VA loans is actually a no-brainer. First, you don’t need to make any down payment. Second, while there is a minimum credit score of 640 mortgage lenders usually ask for, because of the assurance of the Department of Veterans Affairs, lenders are a little laxer when it comes to mortgage rates and the corresponding credit scores. Finally, you can even borrow up to a million dollars (should you need it) because of how powerful this loan program is.
So if you are a veteran or a qualified spouse of one, VA loans are definitely the best deal for you. It’s basically a well-deserved job benefit for serving your country, so if you are eligible, don’t miss out on this great opportunity!
How Can I Improve My Credit Score?
Now that you have read about the different loan options out there, you probably have an idea now of which type of mortgage loan you want to target. And if you have already seen your credit report, the next thing you have to do is improve your credit score.
Here are just some of the tried and tested ways to increase your score before you know it:
1 – Get a credit card.
You probably already have a credit card. After all, at least 79% of American consumers already have at least one credit card account. But, we are here to tell you that it’s time to get another one. That’s right. Instead of having just one credit card, why not take the chance of getting more? But this part is important, so you really have to pay attention. Make sure that you don’t apply for several credit cards all at once. Take it one by one and preferably just every six months regardless of whether you got approved or rejected from the previous application.
Having another credit card can affect your credit score in several ways. At first, it will actually shave a few points from your FICO Score just because you submitted an application, which is why we don’t encourage applying for a lot. However, once you have that card in your hand, you will have many more opportunities to improve your credit score.
A new account means that the overall total amount of money you can borrow at any time is extended by several more dollars, and this can go a long way in improving your credit utilization ratio—just as long as you are not maxing out your credit cards all the time. (Please don’t do that.) It also gives you another payment due date to remember every month, which means that more lines are added to your payment history that can enhance up to 35% of your FICO Score. It may seem like additional work, but if you understand the different perks that come with credit cards, it’s definitely worth your time.
2 – Stay below 30 percent.
If you want to save a lot of money, you have to live within your means. Doing so will also help a lot in improving your debt-to-income ratio (DTI ratio). If you don’t know what that is yet, your DTI ratio reflects the amount of debt you pay for every month against the money you actually make. If you have way less money left every month after paying all your bills, this definitely will not look good to lenders and in your credit report.
If you are using credit cards, make sure that you keep your total amounts due below 30% of your credit limit. You can even spread your purchases across several cards as long as your total never goes over 30 percent. We mentioned DTI ratios, although doing this action will not necessarily improve your DTI if an increase in income does not accompany it. But staying below 30% can affect your overall spending habits, and when you have a great credit utilization ratio, this means a better credit score the next time you see your credit report.
3 – Become an authorized user.
Now, let’s say that you understand all of the above we’ve mentioned, but you prefer to avoid getting a hard inquiry on your credit that will take points off your FICO Score. Even if you don’t mind, however, this next tip can also work for you.
We recommend that you get yourself become what’s called an authorized user on someone else’s credit card account. Of course, for this technique to work, you’ll have to ask someone their credit score, and this person will need to have a lot of trust in you, which is why you’ll definitely want to ask someone close to you for this favor instead of someone you barely know.
This will help your credit score in as fast as 2 months because whatever great credit background they have on their report will eventually trickle into yours as if you are piggybacking on their credit score at absolutely no cost. Of course, you’ll want to make sure that this person continues to maintain a good credit score, though, and if you do get issued a card that’s linked to their account, you have to take care not to abuse the privilege.
4 – Check your credit report thoroughly.
We saved the most basic for last because people often forget just how important it is to check their reports meticulously.
As shocking as it may sound, mistakes on credit reports are actually more common than you might imagine. In fact, in a 2016 episode of Last Week Tonight with John Oliver, it was shared that one woman had someone else’s credit information included in her report that she eventually missed out on getting approved for several loans. Considering how many things in our lives are affected by our credit scores, you don’t want seemingly innocent errors to bar you from the things you absolutely need.
Another reason why it’s important to go through your report line by line is that you can actually dispute some of the details you can find, whether it’s the hard inquiries that you really had nothing to do with or late payments that actually paid on time. Of course, by now, you must understand how much it can lower your credit score if you make even one late payment, so you have to make sure your report is only reflecting the reality always.
And that is it! Maintaining high credit scores means so much more than just paying your bills when you are supposed to, and it doesn’t necessarily mean avoiding debt entirely. Borrowers with credit scores below the minimum credit home loans require still have a big chance of getting approved if only they are willing to do the work needed to clean up their credit history.
There are so many more tips out there waiting to be read by you because, remember, millions of people have been where you are now. This is a problem that has concrete solutions. It can actually become exciting to watch your credit score increase as you take any of the steps we’ve outlined above. The question is, are you up for the challenge?