Mortgage Q&A: “How to get a mortgage with a low credit score.”
If you’ve got a low credit score, but are determined to buy a home (or are looking to refinance your existing mortgage), you may be wondering how to get a mortgage. Or if it’s even possible.
First things first though – how low is your credit score? Are we talking a 660 credit score or a 500 credit score? Everyone seems to have a different definition of low, so let’s start there.
Mortgage lenders rely on FICO scores to make credit decisions. The FICO score range dips as low as 300 and rises as high as 850. The average credit score is somewhere around the high 600s to low 700s at any given time.
I say somewhere because there are always different numbers being cited by different sources, and the data is often outdated. It’s also a moving target that doesn’t stay constant, but average scores don’t stray too far from the high-600 to low-700 range.
Home Loans for Bad Credit
But to get back to my point, you need to assess how low your credit score is to determine your chances of getting approved for a mortgage.
In short, if your score is closer to the bottom of that aforementioned range, your chances of landing a mortgage will become slimmer and slimmer, even for so-called “bad credit home loans.”
Conversely, if your score is simply imperfect and you’re a perfectionist, you might not have anything to worry about. Other than lacking perfection…
Regardless, there are plenty of home loan options for those of us with imperfect credit, or dare I say, bad credit.
In fact, you technically only need a 500 credit score to get an FHA loan, which is actually a popular choice among homeowners these days for its equally low 3.5% down payment requirement. You don’t even have to be a first-time home buyer.
And let’s get one thing straight, a 500 credit score is pretty abysmal. It’s bad credit, no ifs, ands, or buts. I’m not here to judge, but I’m going to give it to you straight.
You don’t just wind up with a 500 credit score after racking up some credit card debt, or because you have student loans. It doesn’t happen by accident.
So if your credit score is at or below 500, you’ve certainly made some serious financial missteps. And you may question why any mortgage lender in their right mind would offer you a home loan. Sure, they’re willing to accept some risk, but within reason.
Anyway, if you thought 500 was low, consider the fact that the VA (home loans for veterans) doesn’t even have a minimum credit score requirement, so a VA loan lender could potentially go even lower. Of course, if they want to remain in good standing and continue to offer VA loans, they probably won’t.
It’s basically lender discretion, and default rates will drive the minimum credit scores they actually deem acceptable for borrowers.
That being said, while mortgage underwriting guidelines may say one thing, banks and lenders could well say something completely different.
This is why borrowers with poor credit are often disappointed once they speak with a lender. You might technically fit the guidelines, but once a lender overlay is applied, you often can’t get financing.
Is Your Credit Score Lower Than 620?
- Fannie Mae and Freddie Mac require 620+ credit scores
- The FHA will go as low as 500, but you need a 580+ score for 3.5% down
- Most lenders want a minimum credit score of 620 for VA loans
- Most banks require a 620-640 score for USDA loans
- Jumbo loans may require scores of 680 or higher
One of the most important three-digit numbers in the mortgage world is 620. Why? Well, anything below a 620 credit score is considered “subprime” by most banks and home loan lenders, not to mention the ever-important Fannie Mae and Freddie Mac.
That’s right, the minimum credit score to get approved for a mortgage loan by that important pair is 620. Anything lower and you’ll need to go back to the drawing board, or at least look for a loan backed by another entity.
For the record, Fannie and Freddie back the lion’s share of mortgages, so a credit score lower than 620 already eliminates you from something like 70% of the mortgage market.
Long story short, you should aim to have credit scores of at least 620 or higher to ensure all loan options are on the table. If not, there are still government loans available, including FHA, VA, and USDA loans.
Speaking of the USDA, their loan program also features no minimum credit score requirement, but like VA loans, individual lenders will typically require reasonably high credit scores, such as 640 or better.
FHA Accepts 500 Scores with a Catch…
As mentioned, the FHA accepts scores as low as 500, but keep in mind that if your credit score is below 580, you’ll need to bring in at least a 10% down payment. You won’t be able to take advantage of their flagship 3.5% down loan program, which requires a 580+ credit score.
And let’s face it – most home buyers are going with the FHA for their low-down payment requirement. I’m not certain, but I doubt very many borrowers are putting 10% down on a house via the FHA.
They’re not so much loans for bad credit as they are loans for home buyers with little set aside for down payment.
Additionally, most mortgage lenders require even higher credit scores for FHA loans, based on their own risk appetite. So a 500 credit score might not actually cut it in the real world, even if the guidelines permit it.
You may find that most FHA lenders want minimum credit scores of 600+, or even 640+, so finding a lender actually willing to lend to someone with bad credit can be trickier than it appears.
Recently, a lender by the name of Carrington Mortgage Services began accepting FICO scores as low as 550 for FHA, USDA, and VA loans, though the associated pricing hit is pretty sizable. And they’re one of the only games in town.
In other words, you’ll pay through the nose for the chance to get a mortgage, and you won’t have much if any negotiating power if they’re the only bank willing to lend to you.
Meanwhile, credit scores of 660 and up are typically required for all other conventional mortgage loans, those not backed by a government agency.
For jumbo mortgages, you might be looking at a minimum score of 680 or even 700, with a large down payment also a requirement. Or a max LTV ratio of 80%, meaning you’ll need a 20% down payment to buy real estate or refinance an existing mortgage.
How to Buy a House with Bad Credit
As noted, there are plenty of options to obtain a home loan if you have bad credit, assuming your credit is truly just bad and not terrible.
Again, this definition can vary, but aiming for FICO scores of least 620 is a good start. If you can’t muster that and need to buy a home today, it might still be possible to get the job done.
You may just have to pay a bit more for it, via higher-than-normal pricing adjustments that could drive your mortgage rate a lot higher.
For example, if you are able to get an FHA loan or a VA loan with bad credit, your interest rate might be 6% instead of 4.5%.
While it’s not the end of the world, it will equate to higher monthly mortgage payments. Aside from not wanting to shell out more for your mortgage each month, it could potentially complicate qualifying.
For example, a higher mortgage payment will lead to a higher debt-to-income ratio (DTI), and that could knock you out of contention.
Additionally, those with low credit scores may only be approved for a mortgage with compensating factors, such as a large amount of assets and/or a higher down payment.
So if you have bad credit and you’re lacking assets, your chances of approval might be quite low. Conversely, if you have poor credit but plenty of money in the bank and a solid employment history, you might be able to squeak through.
If you’ve got bad credit, it might be prudent to enlist a mortgage broker, one who can shop your (more difficult) loan scenario around with multiple banks and lenders to secure financing.
Aside from hopefully finding a home for your loan, they might be able to negotiate lower loan rates and map out a plan for a future refinance once you clean things up.
You can visit your local bank as well, but chances of getting approved for a mortgage with a low credit score are probably pretty slim. Most of the big banks are pretty vanilla, meaning they only accept borrowers with credit scores of 620 and up.
And having to call bank after bank can be time consuming and frustrating to say the least.
Note: Let me just point out that if for the odd reason you’re extremely rich, you could just buy your home with cash and avoid the mortgage route entirely. In this case, it wouldn’t matter if you had bad credit, or any credit whatsoever. When you’re paying cash for real estate, credit scores don’t factor in. Unfortunately, this will be a sliver of the population.
Refinance Your Bad Credit Mortgage
The good news is you can always refinance your bad credit mortgage in the future if and when your credit improves.
Let’s say you take out that high-rate 6% government home loan, then work on your credit and your scores rise from 600 to 680. All of a sudden you’ll have many more loan options, and plenty of lenders will actually be interested in working with you.
Even if you existing mortgage isn’t very attractive, it doesn’t have to be permanent if you make strides in the credit score department.
The presence of a mortgage that is paid on time can also help your credit scores, so simply paying it for a year or so could push your scores higher. If you make a conscious effort to improve your credit otherwise, you won’t be stuck with the mortgage for very long.
Try to remember that as you go through the process – you might have found your forever home, but not your forever home loan, and that’s okay, especially if you don’t want to miss out.
Buying a house with bad credit could just be a means to an end once you turn things around. And most folks don’t hold their mortgages longer than a decade anyway.
Do you want a mortgage if your credit score is low?
Aside from those who absolutely need to buy a home/refinance their mortgage, and those with no other place to turn, are you sure you want to apply for a mortgage if your credit score is in bad shape?
Even if you do manage to get approved, your mortgage rate will probably be much higher as a result, and you’ll likely need to come in with a large down payment to offset the credit risk you present to lenders.
You may be better off having someone else with good or excellent credit take out the loan instead, such as a spouse or parent. Or it may be in your best interest (literally) to wait until your credit score has improved before applying for a mortgage.
I understand that you may not always have that luxury if there’s a house you just must have, but it’s something to consider if you’re more wishy-washy.
In any case, it is recommended that you check your credit scores and corresponding credit reports long before applying for a mortgage to ensure you can actually qualify. Doing so in advance will also give you time to fix any mistakes that may show up on your credit report, as changes can take a lot of time.
Keep in mind that while credit scoring is very important to successfully obtaining a mortgage, if not the most important factor, it is just one of the many underwriting criteria mortgage lenders consider.
Things like income, assets, and employment history can also make or break you, regardless of whether you have perfect credit or not.
No matter your scores, always take the time to compare mortgage lenders to ensure you don’t miss out on a better deal, or worse, miss out completely.