Posted by Helen Ford, PMP, Realtor, GRI at Jul. 24, 2017
Believe it or not, your credit doesn’t have to be stellar to get a mortgage. Many banks and lenders will extend a mortgage to applicants with at least a 640 credit score. However, not all lenders are created equal — and, even if you can score a home loan, bad credit is going to seriously cost you in interest.
What Credit Score Do I Need to Get a Mortgage in 2017?
There are two main types of mortgages: conventional and Federal Housing Administration, or FHA, loans.
Some lenders will offer conventional mortgages to consumers with a credit score of just 620. Other lenders will go even lower, but the process for getting that mortgage will be difficult and involve thorough explanations of your credit history.
For FHA loans, some lenders will go as low as 580, with just 3.5% in equity. However some folks can get a new mortgage or even do a cash-out refinance with a credit score as low as 550 — but there’s a catch. You’ll need at least a 10% equity position. This means you need 10% down when buying a home or 10% equity when refinancing.
Keep in mind, though, not all lenders will extend a mortgage to someone with a bad credit score — it has to do with their tolerance for risk. (From an underwriting perspective, poor credit indicates a higher risk of default.) The more risk a bank is willing to take on, the higher your chances of getting approved with a not-so-hot score. You can see where you currently stand by viewing your two free credit scores on Credit.com.
Here are some things to keep in mind if you have a low credit score and are shopping for a mortgage.
1. It’s a Good Idea to Rebuild Your Credit
If you are looking to increase your credit score to have an easier time getting a mortgage, you’ll need to be able to clear the 620 mark to see any significant difference. Hitting that threshold (and beyond) will likely make better mortgage rates and terms available to you, plus keep you from going through the type of scrutiny a lower tier credit score bracket often requires. You can generally improve your credit score by disputing errors on your credit report, paying down high credit card balances and getting any delinquent accounts back in good standing.
2. Down Payment Assistance Will Be Hard to Come By
Down payment assistance programs are currently quite scarce. Beyond that, to be eligible for down-payment assistance, a borrower would typically need at least a 640 credit score. You can expect this across the board with most banks and lenders. It is reasonable to assume you are ineligible for assistance if your credit score is under 640.
3. Previous Short Sale, Bankruptcy or Foreclosure Are Subject to ‘Seasoning Periods’
If you have one of these items on your credit report, it’s going to impact your ability to get a mortgage. There’s typically a three-year waiting period — also known as a “seasoning period” — before you can qualify for a mortgage after you’ve been through a foreclosure or short sale. The waiting time after a bankruptcy is two years. Note: There are some loan programs that have shorter seasoning periods. For instance, VA loans can get approved at the two-year mark following a foreclosure.
4. Higher Debt-to-Income Ratios Make it Harder
It’s no secret that FHA loans allow debt-to-income ratios in excess of 54%. In order to be eligible for this type of financing, your credit score should be around 640 or higher. That’s not to say your credit score of 620, for example, will not work. It’s almost a guarantee, though, that if your credit score is less than 600 you’re going to have a difficult time getting a loan approved with a debt-to-income ratio exceeding 45%.
5. Cash-Out-Refinancing Is On the Table
This is a big one. If you already own your own home, you could use your equity to improve your credit. How? You could do a cash-out refinance with your home. This would allow you to pay off installment loans and credit cards, which often carry a significantly higher rate of interest than any home loan. Wrapping them into the payment could end up saving you significant money, and it’s still an option for borrowers with lower credit scores. (As I mentioned earlier, some lenders will do a cash-out refinance for borrowers with a credit score as low as 550, so long as they’re in a at least 10% equity position.) However, if this is something you’re considering, be sure to read the print and crunch the numbers to determine if you’ll come out ahead. Cash-out re-fis require you to pay closing costs and your bad credit might not merit a low enough interest rate to make this move worthwhile. You’ll also want to make sure the new monthly mortgage payment is something you can handle.
Remember, just because you can technically get a mortgage with bad credit, doesn’t mean it’s the best move for you. You may want to improve your standing, lower your debt-to-income ratio and bolster your down payment funds before hitting up the housing market. Still, it can be done and if you’re currently looking for a home loan, be sure to ask prospective lenders or mortgage brokers lots of questions to find the best deal you can get.