Your credit score plays an important role in the home buying process. It’s how mortgage lenders determine your ability to responsibly borrow and, more importantly, pay back a loan.
A high credit score will not only qualify you for a loan but will also allow you to access more mortgage options. A low credit score could limit your options of – if not altogether prevent you from – getting a loan.
This can pose a problem for today’s first-time home buyers, as millennials have lower credit compared to the previous generation at the same age. If you find that you’re in the same boat, don’t worry – homeownership could still be a reality for you.
Let’s discuss what home loan options are still available with a lower credit score and then move into how you can improve your credit score.
Types of Loans for Bad Credit
In order to determine your creditworthiness, loan qualification and even interest rate, a mortgage lender will look at your median FICO® Score. These credit scores are calculated based on factors such as:
- Payment history
- Amount owed
- Length of credit history
- Types of credit
- New credit
Using information from three major credit bureaus (Equifax, Experian and TransUnion), FICO compiles findings to assign individuals a credit score between 300 – 850. When determining if a borrower is qualified for a mortgage, lenders consider credit scores as well as other factors, such as income and debt-to-income ratio (DTI).
Here are the minimum credit scores needed for different types of mortgages:
- Conventional loan: 620
- FHA loan: 580
- Department of Agriculture (USDA) and Veteran Affairs (VA) loan: No universal standard specified, but Quicken Loans requires 640
It’s important to remember that there’s more to qualifying for a mortgage than a high credit score. It’s also important to know that each lender might require a different credit score. At the end of the day, you’ll have a higher chance of getting approved for a loan if you have a higher credit score. You’ll also have more mortgage options available to you.
If you find yourself on the lower end of the credit score spectrum, the following home loan options might still available to you.
FHA loans offer a low down payment option (as little as 3.5%) and have lower qualification requirements as far as credit and DTI, compared to conventional loans.
With an FHA loan, you can qualify for a loan with a median FICO Score as low as 580. In order to qualify for an FHA loan with a credit score that’s that low, you’ll need mitigating factors like a low DTI ratio. Additionally, if you declared bankruptcy in the past, you might still be able to qualify for an FHA a year or two after the date of your bankruptcy, as long as you maintained a good credit score after your debts were discharged.
The same goes for a previous home foreclosure. If you foreclosed on a former home but have maintained a good credit score since then, you might be able to qualify three years after the foreclosure date.
Lastly, an FHA loan allows you to have a higher DTI ratio compared to conventional loans, as long as you have a credit score in the mid- to high-600 range (or higher). This is beneficial for first-time home buyers with low income who have debt.
One thing to keep in mind with an FHA loan is that if you put less than 20% down, you’ll have to pay mortgage insurance premium (MIP) for the life of the loan. You could make a down payment of 10% to avoid MIP for the life of the loan, but you’ll still pay it for at least 11 years (unless you refinance once you’ve reached 20% equity in your home).
If you’re an active duty military member, you might also be able to qualify for a VA loan with lower qualification requirements, such as no required down payment, higher allowed DTI and no mortgage insurance payments.
There is no standard required credit score for a VA loan, although some lenders will have a number in mind. For example, Quicken Loans requires a credit score of 620 to qualify for a VA loan. Like an FHA loan, a VA loan is also forgiving on past financial difficulties, like bankruptcy.
There is no down payment required for a VA loan. Additionally, there is no mortgage insurance necessary for a VA loan; instead, you pay a one-time funding fee that can be paid at closing or built into the loan.
Even though the required credit score for a VA loan is higher than an FHA, a VA loan is more lenient with DTI ratios, allowing a ratio as high as 60% in order to qualify for a fixed-rate loan.
Keep in mind that in order to qualify for a VA loan, you have to be currently serving in the United States military, be an honorably discharged veteran or be a not-remarried surviving spouse of a veteran or service member who died in service. You must be able to obtain a VA Certificate of Eligibility (COE), and either you or your spouse (if you’re actively deployed) must live in the home.
Local and Federal Assistance Programs for First-Time Home Buyers
As a first-time home buyer, there are various assistance programs and resources that make the home buying process more attainable.
While Quicken Loans doesn’t offer any in-house programs, we do accept the following.
- HomePath Ready Buyer Program: Fannie Mae offers this product to first-time home buyers (people who have not owned a home in the past three years) the option to purchase foreclosed properties as-is for as little as 3% down. It also offers closing cost assistance in the form of seller concessions.
- Government and charitable grants: The Department of Housing and Urban Development (HUD) offers a list of state and local home buying programs. You can also look for charitable organizations that will help with the financing of a home.
- Employer assistance: Some employers offer loan assistance that is forgivable if you stay with the company for a certain number of years. You might also be able to get assistance from your labor union.
- Borrowing from retirement funds: After checking with your financial advisor/tax professional for advice, you could take a loan from your retirement funds to be paid back over time on a set schedule and use it for down payments or other mortgage transaction costs.
- Mortgage credit certificate: This is a state or local government option that is available for low- to moderate-income buyers to take a credit for a reduction of your tax bill based on your mortgage interest.
Before you consider locking into one of these options, make sure you speak with a Home Loan Expert for more specific qualifications.
Ways to Improve and Monitor Your Credit Score
In some cases, a poor credit score (as well as other financial factors) might lead to you being turned down for a mortgage. If this is the case, you should talk with your lender on why you were denied for a mortgage.
Sometimes a low credit score can be the result of identity theft or previous challenges that no longer affect your financial stability. Be sure to have your payment records and other documentation nearby to help verify your case for a home loan.
If you’re unable to get approved for a home loan because of your credit score, it’s time to build up your credit score. If you’re new to credit and were denied because of your lack of credit history, there are a few ways you can start to show a history of responsible repayment:
- Apply for a secured credit card
- Get a co-signer
- Become an authorized user
- Pay off your student loans, auto loans or rent
If you have credit but maybe had a rough financial past, there are ways you can improve your credit score, which require time. You must be able to prove at least six months of timely payments to start building your score.
Here are a few ways to do so:
- Pay your bills on time
- Don’t use more than 30% of your credit card’s limit
- Don’t open too many accounts at once
- Keep your existing account open
- Check your credit card statements regularly
To summarize, never spend or borrow more than you can afford to pay back and make sure you always make your payments on time. While it might take some time to improve and raise your credit score, the effort is worth the reward.
Additionally, make sure you’re monitoring your credit score by checking your credit card statements regularly, checking for errors and discrepancies, and keeping an eye out for identity theft. Report any issues to your credit card’s fraud department.
You can also monitor your credit score by using sites like QLCredit.com. It’s free and helps you get a grasp on whether you’re ready to reapply for a home loan or should wait and rebuilt your credit score a little longer.
Other Qualification Factors to Consider
Besides your credit score, there are other qualification factors to consider when you’re applying for a mortgage. These could affect the number of options available to you or the interest rate you receive on the loan.
Down Payment Amount
Like credit score requirements, lenders also require a certain down payment amount depending on the mortgage option you’re applying for. These are typical minimum requirements:
- Conventional loans: at least 3%
- FHA loans: at least 3.5%
- VA and USDA loans: nothing required
If you’re unable to provide the minimum down payment amount and have a low credit score, you might have a hard time being approved for a home loan.
If you don’t have the cash for a large down payment on hand, look for assets that you can liquidate without taking large losses. For example, your retirement account could be a source of cash for your down payment.
Another way to fund your down payment is with gift money from relatives. However, the amount of gift money you use can actually affect the mortgage type for which you qualify. Learn more about how using gift money impacts your loan approval with our guide to using gift money for your down payment.
You can also take this course to learn how to save up for a down payment in 180 days.
Your DTI ratio measures your ability to make payments toward money you’ve borrowed based on your total minimum monthly debt divided by your gross monthly income. Your lender will consider car loans, student loans, credit card debt, home equity loans, mortgages and any other reoccurring debt to calculate this percentage.
Most lenders will consider a DTI less than 50% as acceptable when qualifying you for a mortgage, but the lower your DTI, the more loan options will be made available to you.
There are some options that can help you work around your DTI ratio. For an FHA or VA mortgage, if you have a credit score in the 600s, your lender might excuse a higher DTI amount. Other than that, working on paying off your debts is a good way to lower your DTI and get approved for a mortgage.
Knowing what lenders look for is one of the top things first-time home buyers need to know before applying for a loan. Although these guidelines apply for Quicken Loans, it’s important to note that each lender might have different standards for qualification.
If you’ve read this article, examined your financial situation and are ready to take the plunge into homeownership, you can do so online with Rocket Mortgage® by Quicken Loans® or chat with one of our Home Loan Experts at (800) 785-4788. If you still have questions, you can let us know in the comments below.
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