Buying a home is not an easy process and can be especially difficult if your credit score is low. A low FICO score or limited credit history can make it a challenge to qualify for a mortgage. Don’t give up though! You have financing options that can help you buy that new home you’re dreaming of. Some time and research will help you find the best home loan options for you.
What Is a FICO Score?
A FICO score is a credit scoring method created by the Fair Isaac Corporation2. FICO scores weigh five areas to calculate creditworthiness: the amount of outstanding debt, payment history, types of credit used, newly opened credit accounts and credit history. Lenders use the score along with other financial information to assess credit risk. Once credit risk is assessed, a decision will be made whether to extend credit.
As many as 34 percent of Americans have FICO scores lower than 670. Credit scores between the range of 580 and 669 are considered fair. Scores below 579 are considered poor. Even the average credit score of 675 is in most cases too low to meet the requirements to get the best rates on a conventional home loan. Once the credit score goes below 700, interest rates rise. Although it may seem like a daunting task, purchasing a mortgage with bad credit is not completely impossible and there are options.
FHA Loans are an option for potential borrowers with less than perfect credit. The loans are insured by the Federal Housing Administration1 and were developed to help those who would not ordinarily qualify to obtain a home mortgage. It is possible to meet the qualifications for an FHA mortgage with a credit score between 500 and 579 points. The down payment requirement is also an attractive component of the program. The required down payment for an FHA mortgage can be as low as 3.5 percent. Another attractive feature of FHA loans is the reduced closing cost expenses. Because the loans are backed by the federal government, the risk to lenders is reduced if the mortgage should ever go into default.
To meet the qualifications for an FHA loan, the buyer will need to meet the following requirements:
- Minimum credit score of 500 and a 10 percent down payment
- Minimum credit score of 580 and a 3.5 percent down payment
- Steady employment history including proof of employment at the same company for at least 3 years
- A Social Security number
- U.S. citizenship or residency
Individuals with a low credit score and who have served in the U.S Military should consider applying for a VA loan when looking to purchase a home. The loans are only offered to members on active duty and veterans. Like FHA loans, VA loans are backed by the government and offer competitive interest rates. Where VA loans differ is that there is no private mortgage insurance requirement. The fees are also significantly lower.
Those with low credit scores can take advantage of the flexibility that VA loans offer. The mortgages do not require a down payment. This gives the buyer increased purchasing power with less financial strain. Lenders that offer VA loans also offer flexible credit score requirements. A buyer can qualify with a score of 620 or lower depending on the lender. To qualify for a VA loan, you will have to meet the following eligibility requirements:
- Have served at least 90 consecutive days of active service during wartime
- Have served at least 181 days of active service during peacetime
- Have more than 6 years of Reserve or National Guard service
- Meet the lender’s minimum credit score requirements
- Increase the Down Payment
Lenders like to see that borrowers are willing to contribute to the risk of the home loan. With an increased down payment, the lender may be willing to relax on the credit requirements. A few things are considered when a loan application is being reviewed: credit score, debt to income ratio and loan to value ratio. It may be possible to offset a low credit score with a larger down payment which could improve the loan to value. This means that less money will need to be borrowed for the purchase.
Shop for a Home Loan at Community Banks and Credit Unions
The lending and credit criteria at a community bank or credit union may be less rigid than at a bank. Also, credit unions are nonprofit financial institutions that were created to service members of a community, so they may offer special home loan programs with favorable terms for members.
Improve Your Credit Score
Credit scores fluctuate, and it is worthwhile to try to improve your credit score as soon as the decision is made to purchase a home. Examine your credit report, fix any errors and pay down the balances on credit cards. It is also important to avoid paying bills late. In many cases, a low credit score is the result of high balances and late payments. Improving your payment history will improve your score.
A low credit score does not have to prevent you from securing a home loan. Once the goal is set to be a homeowner, you may find yourself motivated to improve your credit and look for options that will allow for financing.