Life happens. Anyone can hit a financial brick wall and suddenly find that their credit score is spiraling downward. Will a low credit score result in high mortgage payments that will prevent you from becoming a homeowner?
Not necessarily, according to the U.S. Department of Housing and Urban Development, as long as your credit woes are minor, temporary or the result of unique circumstances. The good news is that there really isn’t a carved-in-stone minimum credit score you need to qualify for a mortgage for your home purchase. It can vary by lender, but you'll probably end up paying a higher interest rate if your credit score qualifies as a bad credit score.
What’s in a Credit Score?
The first step in buying a home is understanding what goes into a credit score, and how mortgage lenders use that magic, three-digit number. You actually have more than one credit score because they’re provided by the three major credit bureaus: Experian, Equifax and TransUnion. Mortgage lenders typically use the score in the middle. For example, if your credit score ranges from 600-620 with individual scores of 600, 610 and 620, they’ll use 610 for purposes of qualifying you.
The credit bureaus arrive at these numbers by weighing various factors. They break down like this for FICO scores. The most commonly used components of these credit scores:
- Payment history contributes 35 percent of your score.
- Credit utilization makes up 30 percent of your score.
- The length of your credit history - how long you’ve been borrowing - accounts for 15 percent of your score.
- The different loan types of the accounts you have contributes 10 percent of your score.
- How much new credit you have accounts for 10 percent of your score.
Your payment history takes into account how many times you’ve been late with a monthly payment to a creditor. A single late payment can linger on your credit report and influence your credit score for up to seven years. Credit utilization is how much of your available credit lines you’ve used.
Read More: What Credit Score Do You Need To Buy A House
Ideally, you’ve been borrowing for a good many years – longer is better – and you have a balance of different types of accounts: auto loans, personal loans, student loans, credit cards, or a previous mortgage. Too many new accounts will drag down the average age of your other accounts, and this can make it appear that you’ve been borrowing for a shorter amount of time. It can also indicate to lenders that you were desperate to get your hands on money if you have a lot of new accounts.
The best interest rates are reserved for those with good credit, scores in the range of the mid-700s or higher, and a score lower than 620 might impact your eligibility, making it hard for you to qualify for a mortgage, at least unless you take other steps. Your loan options will be significantly limited with a “bad” credit score below 580, but even then, it’s not a foregone conclusion that you can’t get a mortgage.
Read More: Credit Score for Mortgage Rates: How It Works
Check Your Report Before You Apply
Forewarned is forearmed, so you should begin your homebuying process knowing what your credit reports say before you begin shopping for a mortgage and negotiating a loan amount. Get copies from each of the reporting bureaus, because the information that's included might vary slightly. Make sure that everything on there is accurate, and take steps to dispute any information that isn't. You’re entitled to one free credit report per year from each of the reporting agencies under normal circumstances, and you can get them as frequently as once a week during the age of COVID-19.
You'll want to purchase your credit scores as well. These typically aren't free, but the cost is nominal.
Explore Your Borrowing Options
You can begin shopping for a mortgage when you know the minimum credit score requirements and your credit scores and have a firm idea of what you’re working with. This begins with knowing what types of mortgage options are available.
A Federal Housing Administration (FHA) mortgage is probably your best bet if you have a lower credit score that falls below 620, according to the Consumer Financial Protection Bureau (CFPB). The FHA won’t actually advance you the money for a mortgage, but it guarantees lenders that they’ll be paid if you default. This gives lenders more of a comfort level to extend a bad credit home loan.
FHA loans typically require a credit score of just 580 if you can make a down payment of at least 3.5 percent. You have to come up with 10 percent down if your score is as low as 500. Keep in mind that these are only the FHA's guidelines. Lenders are free to require higher scores, although they’re still much more flexible with this type of home loan than with conventional loans. According to the Urban Institute, about 75 percent of FHA borrowers had credit scores below 640 in 2018.
VA Loans & USDA Loans
Department of Veterans Affairs (VA) loans are forgiving of poor credit scores as well. They’re available to military service members, both active and retired. U.S. Department of Agriculture (USDA) loans give you the benefit of the doubt with a lower score, although this program requires that you purchase a home in a rural area.
A “subprime” or bad credit mortgage loan from a conventional mortgage lender will most likely cost you a great deal more in interest as reflected in the mortgage rate, if you can qualify at all. Subprime loan terms aren't as favorable as those granted to consumers with prime credit scores. You’ll probably need a credit score of at least 620 for a prime loan program.
Other Contributing Factors
You might be able to work around a bad score and secure financing anyway under some circumstances. For example, making a more significant down payment than the down payment requirement – if you can swing it – has been known to convince mortgage brokers to be a little more forgiving of low credit scores.
You might look into programs for first-time homebuyers in your area if this is your initial foray into real estate purchasing, and you simply don’t have the cash available to make a down payment that will make lenders smile, typically in the neighborhood of 20 percent. These assistance programs are often funded by the federal government, and several offer down payment assistance. Your chances of loan approval should improve significantly if you can put down 20 percent – not to mention that your interest rate should drop to a lower rate as well.
Read More: What Are First-Time Homeowner Programs?
Having a healthy income that decreases your debt-to-income ratio, along with job security, can be a plus, too. Recent job or career changes might not work in your favor, even if they’re a step up. It’s the timing that matters. Ideally, you'll have at least two months’ living expenses tucked away in savings as “reserve” payments toward your mortgage. This will improve your chances of approval as well. And if you have any debts in collection, you need to tidy them up and pay them off ASAP before making your loan application.
You might want to plead your case with a lender if your low credit score is the result of what the CFPB calls “extenuating circumstances.” Maybe your credit took a serious hit due to a situation that was largely beyond your control, such as a one-time event that led you to file for bankruptcy or foreclosure on your previous home. This is particularly the case with FHA loans because they're more flexible. There’s usually a two- to three-year waiting period after these events with an FHA loan, but it's much longer with conventional loans. You might be able to convince a lender to shave some time off even these homeownership deadlines under certain circumstances.
- Consumer Financial Protection Bureau: How to Deal With “Bad Credit” – or No Credit – When You Want to Buy a Home
- HUD.gov: Looking for the Best Mortgage
- Badcredit.org: 5 Steps to Get a Loan as a First-Time Homebuyer With Bad Credit
- Urban Institute: Barriers to Accessing Home Ownership – Down Payment, Credit, and Affordability
- Rocket Mortgage: Buying a House With Bad Credit – A Guide to Your Home Loan Options
- Quicken Loans: Can You Get a Home Loan With Bad Credit?
- Federal Trade Commission Consumer Information: Free Credit Reports
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.