Many people that rent a house are interested in buying their own home but think that they cannot get approved for a mortgage because of a bad credit score. This guide will teach you the minimum credit score requirements to get a home loan. You’ll also learn whether it’s possible to get a mortgage with bad credit.
Poor credit isn’t cut and dry. Some situations may automatically disqualify you from getting approved for a loan, but not all bad credit is a deal breaker when it comes to buying a house.
Overall Financing Requirements
If you search the internet for information about credit requirements to get a mortgage, you’ll mostly find the same generic information. Government controlled companies Fannie Mae and Freddie Mac end up buying most of the mortgages in the USA, so you ultimately have to meet their minimum requirements for different types of loans. However, it’s important to remember that their minimum requirements can be increased by individual banks and lenders.
For example, conventional mortgages require a minimum score of 620 officially. Unfortunately, not many lenders will actually offer you a mortgage with a score of 620 though. 640 to 680 seems to be a more common requirement. If you approach home buying with the official numbers in mind, you may find a big surprise waiting for you when you try to get approval. This can completely derail buying plans, so it’s an important factor to consider up front.
In general, if you’re barely above the official requirements, shop around to try to find a lender that will work with you. Also keep in mind how these companies will determine your score. If you know your own score, that number comes from one of the three credit reporting agencies. A potential lender will get your score from all three bureaus and throw out the highest and lowest scores. The actual numbers they calculate may even be different from the numbers you can see, to complicate matters even more. You may think you’re a 680 but officially you could end up being 5 or 10 points lower when it comes to a mortgage approval.
Even a perfect credit score could get denied a home loan to buy a house, so your number isn’t everything. Your debt to income (DTI) ratio can make or break an application even when all other factors are okay. 36% is the official limit but this can actually be stretched to 45% or even 50% in many cases. Total your debts and divide them by your income. Income will be gross income for most people, but it is actually calculated from net income when you are self-employed.
What is DTI and how do you calculate it? Debts will include your future mortgage payment with taxes and insurance. Beyond that, it will also include any other self-reported debts or anything that shows up on any of your three agency reports. Open revolving credit accounts like credit cards and car payments are included. Collection accounts are also included, which I’ll discuss in more detail in the next section.
Using a credit boosting service, such as through Experian, can actually harm you in this situation. The boosted score only increases one of your three bureau scores, so a boosted score is often the highest and thrown out without benefiting you any. On top of that, when DTI is calculated they will include these self-reported accounts as debt.
I’m 100% self-employed and obtained my mortgage under those circumstances. I had accounts factors into my DTI that were business expenses. Being self-employed, my business expenses are deducted on my taxes and my mortgage is based on my net income. This means I had income that wasn’t counted towards the mortgage and expenses from the excluded income were still counted towards my DTI. Luckily, I had a lot of extra leeway with my debt to income ratio and this didn’t affect me, but it would’ve caused problems if I had been trying to buy a house at the upper end of my income level.
Once an account goes into collections and drops your score as a result, it won’t actually hurt your score more than that. Paying them off won’t improve your score either. Having accounts in collections won’t automatically disqualify you from getting a mortgage. I had a number of old accounts in collections on my report still when I received my home loan. However, recent accounts in collections aren’t good and may hurt you.
I’m mentioning these types of accounts in this article because it’s a big concern for many people. It’s common to think you will get denied for a mortgage loan with collection accounts on your credit report, but that’s not always true.
if you do have accounts in collections, the main thing you need to consider is what they will contribute to your debt to income ratio. Even if you’re not currently paying these debts and have no intention of ever paying them, a monthly payment will still be calculated for each collections account for your DTI. Even though it didn’t matter in the end because my DTI was low, these additional debts included took me by surprise. It could’ve caused my application to be denied if my income had been lower or if I wanted a more expensive house.
Conventional Home Loans
The official minimum credit score requirement for a conventional home loan is 620. That number can be deceiving though, since each individual lender is able to set their own requirements as long as they aren’t lower than the official requirements. I’ve found most conventional mortgages to require a score of at least 640 and some lenders will even require up to 680.
In general, you’ll want to have fairly strong credit to get a conventional loan. Lower scores that still get approved will simply get higher interest rates and higher monthly payments.
If you have a borderline credit score to get approved, shop around with different banks and lenders. A lot of people will try their own bank and stop there if they don’t get approved, but there are actually a lot of other sources out there to try, especially online.
Except for cash offers, conventional mortgages are usually the most attractive to home sellers. Lower credit options will often have more requirements on the house being purchased, which can put additional restrictions on the seller. Conventional loans also offer higher financing levels compared with FHA loans, so they can be used to buy more expensive houses. These loans will also not require Private Mortage Insurance (PMI) when you put 20% down, so you’ll often get a lower payment with this choice.
The official lowest possible score to get an FHA home loan is 500, but that is with a 10% down payment requirement. With a 580 minimum score, you can get an FHA loan with as low as 3.5% down. While those are the official numbers, you’ll run into the same problem as conventional loans here – some lenders will simply require higher scores.
It’s actually hard to find FHA lenders that will work with a score as low as 500, so 580 is a much more common minimum for those with bad credit. Some lenders may even want to see 600 or 620 to approve for an FHA loan. Each area will have a purchase price limit with this loan, so you may need a larger down payment to buy a more expensive house with this option.
Ultimately, FHA mortgages have requirements for home sellers too. Their houses must meet certain conditions to qualify for this type of loan, so this additional restriction can actually cause some sellers to avoid these loans, especially if they know their house won’t qualify. Major items like the roof and things like the AC have to have a certain amount of lifespan left in them. Some of the requirements are sillier, like requiring railings on steps.
Even if you have a score good enough for a conventional loan, if your DTI is too high to get approved then you may still be able to get approved for an FHA. One big downside to these loans is the requirement for PMI. This additional insurance will simply make your monthly payment higher for the first 12 years of your mortgage. Even if you put 20% down on the mortgage, you’ll still get charged PMI for 12 years going this route.
Technically, VA loans don’t have an official credit score requirement. However, this isn’t usually the case in reality. Most lenders set their own rules and want to see a score of at least 580. With a 0% down payment requirement, this is usually one of the most appealing types of loans, but you or your spouse must be active or former US military to qualify.
You will still need cash to get this type of loan though, since there is a funding fee and you’ll still have closing costs. Even though this option doesn’t let you buy a house for zero money up front, it’s still the cheapest option of them all.
In general, if you can qualify for a VA mortgage, you should take it unless there’s a good reason to choose another option, such as a high purchase price.