When newlyweds Ronald and Kyra Sells, 26 and 22, began their homebuying process months before their wedding, they felt confident that they’d qualify for a mortgage. However, with scores at 610 and 680, respectively, the couple, from Hamden, Conn., worried they’d be hit with a high interest rate. Ronald’s score, the lower of the two, was due in part to the massive credit card debt he racked up when paying his way through college. And Kyra, a behavioral technician at a school for children with special needs, had student loans, but not much else, in her credit history.
The average credit score of homebuyers is above 700, according to data from the Urban Institute. For buyers that fall below that mark or who have no credit score, the road to homeownership can be challenging and expensive.
What do mortgage lenders consider as poor credit?
Different lenders have different requirements when it comes to credit scores. Though you can qualify for a mortgage backed by the Federal Housing Administration (FHA) with a credit score of just 500, most lenders require your score to be at least 620. Plus, the higher the credit score, the more favorable the loan terms. That’s because, generally speaking, a consumer with bad or poor credit may have one or more of the following, making them a risky investment:
- a history of late payments
- a high debt-to-income ratio (DTI)
- high balances on credit cards and loans
- too many new accounts
- negative events such as collection items, a loan default, bankruptcy, foreclosure or short sale
There are multiple credit-scoring models, but most lenders use FICO® Scores, created by Fair Isaac Corporation. FICO® Scores range from 300 to 850, with the average score recently hitting an all-time high of 711. Scores significantly below that mark are considered either fair or poor.
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Here’s a breakdown of the FICO rating system:
- Poor: credit score between 300 and 579
- Fair: credit score between 580 and 669
- Good: credit score between 670 and 739
- Very good: credit score between 740 and 799
- Exceptional: credit score between 800 and 850
If your credit is less than perfect, you still have options
Consumers without stellar credit don’t have to give up on homeownership. Buyers can still get into the home of their dreams with the help of loan programs with lenient requirements and strategies to offset low credit scores.
With one score in the “good” range and one in the “fair” category, the Sells began watching their credit almost obsessively before applying for a loan, they said. They also sought ways to improve their chances of approval. Ronald, who works in advertising, paid off over $5,000 of his credit card debt, bumping his score up to 640 and lowering their overall DTI. In the end, the couple had no issues getting a mortgage and were able to secure a decent interest rate despite their concerns.
Here are some tips for getting a mortgage without perfect credit.
1. Dispute errors on your credit report. Mistakes on your credit reports could impact your score, so dispute them right away. Consumers can get a free copy of their credit report from each of the three major credit bureaus, Equifax, Experian and TransUnion, at annualcreditreport.com.
2. Review your loan options. Some loans may be harder to qualify for with below-average credit, but there are many options for borrowers with lower scores or no scores.
- Conventional loans. Non-government loans are called conventional mortgages and have stricter requirements. Borrowers must have a minimum credit score of 620. And most lenders look for a DTI of 45% or less.
- HomeReady and Home Possible loans. These programs are options that fall under the umbrella of conventional loans. Insured by Fannie Mae and Freddie Mac, respectively, both loans permit borrowers without credit scores to use alternative credit sources.
- Government loans. Mortgages backed by the government have flexible requirements and are usually easier to qualify for.
Borrowers have three options:
- FHA loans. Mortgages insured by the Federal Housing Administration (FHA) require a credit score of 580 and a 3.5% down payment. Borrowers with scores between 500 and 579 can still qualify if they put 10% down.
- VA loans. Veterans and eligible military personnel can get loans insured by the U.S. Department of Veterans Affairs (VA). These loans don’t require a credit score; however, VA-approved lenders typically look for a 620 score or higher.
- USDA loans. Low- and moderate-income borrowers in rural areas can secure loans from The U.S. Department of Agriculture (USDA) or USDA-approved lenders. No credit score is required for buyers who go directly through the USDA, but most lenders will require a 640 score for automatic approval. Lenders may have different or additional loan qualifications. Also, some banks and mortgage companies may offer proprietary loan programs with flexible credit requirements.
3. Expect to pay mortgage insurance. To counter the risk of lending to buyers who don’t have good credit or put a smaller down payment, some lenders require borrowers to pay some form of mortgage insurance or funding fee. This fee protects the lender in the event you default on the loan. Borrowers can pay mortgage insurance upfront or include it in their monthly payments.
4. Save for a bigger down payment. A large down payment can offset a low credit score depending on the loan and lender requirements. And it could mean paying less private mortgage insurance (PMI) on conventional loans.
5. Offset higher interest rates. Typically, the most competitive interest rates go to buyers with higher credit scores. But there are ways to offset the impact a low score can have on your interest rate.
For example, when the Sells applied for their mortgage in late 2019, they were approved for loans ranging from 4.3% to 5%. They went with the 4.3% loan and opted to purchase points (prepaid interest) to get the rate down to 4.1%. This move cost the couple about $3,000, which they were willing to pay to lower their monthly payment.
5 tips to improve your credit score
Having a higher credit score gives you more financing options. It also qualifies you for better loan terms. Here are some ways to improve your credit and bump up your score.
- Pay your current bills on time. Payment history accounts for 35% of your FICO Score. So, one of the best ways to improve your score is to pay all your bills on time.
- Pay down debt. Another critical factor of your credit score is your credit utilization. This is the amount of debt you owe in proportion to your available credit — the lower your credit utilization, the better. So keep your credit card balances low and installment loans current, making additional payments when you can.
- Avoid taking on new debt. In most cases, you want to avoid getting a credit card or any other form of debt just before applying for a mortgage. New credit typically dings your credit initially.
- Limit the number of inquiries on your report. Multiple inquiries on your credit report can hurt your score. If you plan to compare rates when mortgage shopping, do it within a focused period.
- Wait. Delaying a home purchase certainly isn’t the most popular option. But letting time pass could be an effective solution, especially if you have adverse events in your history.
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