It’s not hard to get a couple of blemishes on your credit report. Whether it’s the mistakes of youth or an unexpected medical procedure that puts you behind on bills, it’s easy to have your credit dip if you’re not careful.
If you have less-than-optimal credit, it’s more difficult to prepare to get a mortgage, but just because your credit score is suboptimal doesn’t mean you have to give up on your dream of homeownership.
In this post, we go over what it means have a low credit score, the difference between bad credit and no credit, and how to improve your score. Finally, we’ll go over the best loans for people with less-than-perfect credit.
Defining Low Credit
We can talk about credit all day long, but it doesn’t make much sense if you don’t know what to measure it against since you’ll have no idea where you stand.
The main credit scoring system used by most mortgage lenders is FICO. Scores range from 300 to 850. With a credit score below 580, it’s difficult to get a mortgage. While possible, you’ll have higher rates and less favorable loan terms. For the purposes of getting a mortgage, a low credit score would be considered below 580.
Low Credit vs. No Credit
Having a low credit score due to late payments or something like a bankruptcy is different from having no credit. If you have no credit, you need to do something to build it up before getting a loan.
If you have no credit and your score is currently at around 300 because you’ve never had credit before, there are a few steps you can take.
Secured Credit Cards
One good way to build credit when you’re first getting started is to get a secured credit card. With this card, you put down a deposit of your own money that serves as the credit line. As you charge things and make the payments every month, your score will start to increase. After maybe six months or a year, your score should be high enough that you can get a more traditional credit card where the credit card company is putting up their own funds based on their faith in your ability to make the payment.
Ordinarily, we don’t advise closing any credit lines because part of your credit score is how many lines of credit you have open that you can manage responsibly. However, secured cards sometimes come with monthly maintenance fees that you don’t want to pay forever, and you want your deposit back.
If you do choose to eventually close this line of credit, be sure to have a couple of other cards open and be aware that your score will take a temporary hit.
Become an Authorized User
You can also piggyback off someone else’s good credit rating by becoming an authorized user on their card. When they make their payment on time every month, your credit score goes up. This is a great way for parents to help their kids get started with good credit.
Understanding Your Credit Score
If you have bad credit due to past negative events, the first thing you need to do is know exactly what’s on your credit report so that you can know where you need to improve.
Our friends over at QLCredit can help you get your VantageScore 3.0 credit report and score for free from TransUnion every two weeks without affecting your score. This will not only show you what’s on your credit report but also give you ideas on where you can improve.
There are five main factors that influence your credit score:
- Payment history (35%): On-time payments help your score, while late payments hurt.
- Balances owed (30%): Your credit utilization is the amount you owe compared to your overall balance. The lower your credit utilization, the better your score.
- Length of your credit history (15%): The longer you have your credit accounts open, the better.
- Credit inquiries (10%): If you’re applying for credit or any kind of loan, it’s considered a hard inquiry and affects your score. If you apply for the same type of loan over the course of 30 days while rate shopping, it all counts as one inquiry. Also, soft inquiries on sites like QLCredit to find out what’s on your report don’t count.
- Credit mix (10%): Another thing creditors want to see is that you have various types of loans and credit. You want to have not only a credit card but also a car or a personal loan.
Other items, like bankruptcies, judgments, collections and charge-offs, can also affect your score. These are bit beyond the scope of this post, but there are things you can do to take care of them.
Explaining Your Low Credit Score
Communicating with a lender during the process is important. If you know what’s going on with your credit, they may be able to help you come up with steps you can take in order to get your credit fixed and get qualified.
This will also help the lender set appropriate expectations for you. If you’ve had a bankruptcy or foreclosure in the past, there may be a waiting period before you can get a mortgage again. Whether you can get a mortgage or not, you’ll know what to expect going in.
Getting a Mortgage with a Lower Credit Score
If you have a less-than-perfect credit, probably the easiest loan to qualify for is FHA. You can get a loan with a credit score is low as 580, assuming you meet other qualifying factors.
If you have a credit score of 620 or higher, you can also qualify with a slightly higher debt-to-income (DTI) ratio – a measurement of the amount of your monthly income that goes to debt payments – of up to 55%, depending on the loan purpose and your other qualification factors. These are Quicken Loans requirements. Other lenders may have different policies.
It’s worth noting that if you make the minimum 3.5% down payment on an FHA loan, you’re going to have to pay mortgage insurance for the lifetime of the loan. With that said, you can always refinance into a conventional loan once your credit score gets to 620 or higher. On a conventional loan, mortgage insurance payments stop once you reach 20% equity.
If you’re still looking for tips, there are a variety of paths to rebuilding your credit.
If you think you’re ready to get started with your loan, you can fill out an online application. Otherwise, if you would like to get started over the phone, one of our Home Loan Experts would be happy to take your call at (800) 785-4788. If you still have any questions, you can put them in the comments below.
If so, subscribe now for tips on home, money, and life delivered straight to your inbox.