Planning to buy a home in the near future? Before you start shopping, you’ll need to shop around for a home loan and get pre-approved so you’ll know which price points are an option. And when working with a lender, one of the primary factors they’ll consider is your credit score. But what credit score is needed to buy a house? It depends.
Read on to learn more.
Why Your Credit Score Matters
Mortgage lenders want to minimize losses as much as possible. So if your credit score is relatively low, the lender may deny the loan or assess a higher interest rate to protect themselves. For the latter, a minor increase of just 1 percent could cost you several thousands more over the life of the loan.
Why so? Your credit score is a measure of your creditworthiness, or the likelihood that you’ll responsibly manage outstanding debt obligations and ultimately repay what you owe. It’s also a reflection of how you manage your finances and is indicative of trends.
For example, if you consistently make late payments on credit cards, your payment history (which accounts for 35 percent of your FICO score), will take a hit, thus lowering your credit score. The same rule applies for amounts owed to creditors (which accounts for 30 percent of your FICO score); the higher the balances you carry, the lower your credit score. High debt balances can also be an indicator that you’re overextended and rely on debt to get by.
Consequently, if your score is in the trenches, there’s a higher chance you won’t be able to keep up with your mortgage payments, which puts the lender at risk.
What’s the Minimum Credit Score Needed to Get a Home Loan?
While there are programs that allow you to qualify for a mortgage with a credit score as low as 500, that’s probably not the route you want to take. A safer route is to get your score to at least 620 with all three credit bureaus before you start applying. And if you want the most competitive rates around, aim for a 740 or higher.
But keep in mind that the minimum credit score needed to get a home loan will depend on the financial institution and type of loan program.
Quick note: Lenders will average your three credit scores and take the middle score into consideration when analyzing your application for a home loan. (But if two scores are identical, that’s the score they will use).
Conventional loans are best for potential borrowers with good or excellent credit as their lending standards are quite stringent. Expect the lender to require a credit score of at least 620 (640 in many cases) and a down payment of 5 to 20 percent. And if you want the most competitive rate, you’ll want to be in the 700s.
Some lenders offer conventional loans with only 3 percent down through Fannie Mae’s HomeReady loan program if your credit score is 620 or higher. You may also be able to take advantage of a 3 percent down conventional loan through the Freddie Mac Home Possible mortgage program.
Government-backed loans are a more viable option if you have less than perfect credit, low to moderate income, or little money saved for a down payment. These include:
- FHA loans- requires a minimum credit score of 580 and 3.5 percent down. You can still qualify for a loan with a score as low as 500 if you have 10 percent to put down.
- USDA loans- requires a minimum credit score of 640 with no money down.
- VA loans- credit score requirements vary, and you don’t have to put money down.
Other Factors Mortgage Lenders Consider
Beyond credit scores, there are a few other significant factors that mortgage lenders consider when reviewing loan applications:
Condition of the Home
If the home isn’t up to par and will need a ton of repairs, the lender may not be willing to underwrite the loan. They may also refuse to extend funding to you if the home is priced well above market value and the seller isn’t willing to budge on the listing price.
Do you have a steady source of employment? The lender will want to know that you’ll have an adequate sum of income coming in each month to cover your mortgage and other expenses. To substantiate the income listed on your application, the lender will request pay stubs, W-2s, tax returns, and bank statements.
Other Debt Obligations
Another important factor is your debt to income ratio, which is the percentage of your gross income that is comprised of debt obligations (including the monthly mortgage). In most instances, the lender prefers that this number is 43 percent or lower, but some loan programs allow debt to income ratios of up to 57 percent.
To illustrate, if your gross (pre-tax) earnings are $6,000, your debt to income ratio should not exceed $2,580. So if the aggregate sum of your minimum monthly payments on credit cards, student loans, and auto loans is $1,250, your monthly mortgage payment should not exceed $1,300. This figure must account for the principal, interest, taxes, homeowner’s insurance, PMI< and any applicable HOA and CDD fees.
How to Get a Mortgage with Bad Credit
Worried that your credit rating will prevent you from getting a home loan? Don’t fret as homeownership may still be a possibility for you under the right program.
Be Transparent with the Lender
Explain the reason for your low credit score and provide proof to demonstrate that your financial and credit troubles are a thing of the past. If you struggled to make ends meet due to a layoff a few years back, communicate that and present the lender with documents to show that you’ve made timely payments on all your obligations (debt and living expenses) since finding new and more stable employment.
Or if medical bills were a major problem, hand over documents that show proof of any communication that you’ve had with the debt collector regarding payment arrangements. And try drafting up a letter to plead your case if all else fails.
What’s most important is that you’re honest out the gate. The lender wants to do all they can to get you approved for a home loan, and credit doesn’t have to hold you back. But if you’re not upfront, they may have reason to believe that you’re trying to conceal integral information and could deny you for a home loan.
As mentioned, there are several government-backed loan programs that are designed to prospective borrowers with credit challenges. If you’re a veteran, take advantage of VA loans since lenders tend to accept those with lower credit scores, and you may be able to secure 100 percent financing. USDA loans also offer 100 percent financing, and they are ideal if you’re looking in a rural area.
And if neither of these options work for you, FHA loans are always worth considering as the rates are competitive, even if your score isn’t that great. But keep in mind that they’re accompanied by private mortgage insurance (PMI) for the life of the loan.
Make a Larger Down Payment
To prove to the lender that you deserve a chance, you could try offering up a larger down payment or padding your reserves. This will prove to them that you’re serious about qualifying and keeping current on mortgage payments.
Get a Cosigner
If all else fails, you can get a cosigner with good or excellent credit to help you qualify for a loan. This may be difficult to do and if you are successful, bear in mind that they’ll be on the hook for the loan as well. So if you hit a rough financial patch and default on the loan or go into foreclosure, they’ll be responsible for picking up the slack and making payments. The co-signers credit score will also be impacted.
Will a Foreclosure or Bankruptcy Prevent You From Getting a Mortgage?
Not necessarily. In fact, you could get a mortgage in as little as two years following a bankruptcy. However, some mortgage lenders may require you to wait up to four years before they’ll consider you for a home loan.
On the other hand, foreclosures may cause you to wait a bit longer. You may have luck if at least three years have passed. However, select lenders may require that you wait up to seven years to qualify for a new mortgage
How to Get a Mortgage with No Credit
Unfortunately, having no credit at all could hurt you just as much as having bad credit when trying to buy a house. This means you’ll need to start establishing credit history. A few tips:
- Apply for a credit-builder loan and make timely payments each month.
- Open a secured credit card and pay off most of the balance each month.
- Ask your landlord, utility, and other service providers to report your payment history to the credit bureaus.
It may take a few months to establish credit history, but it’ll be worth the effort. And you’ll be starting off in the best possible position with a strong credit score.
What to Do If You’re Denied for a Mortgage
Still no luck? All hope is not lost. In fact, you should use this as an opportunity to boost your credit so you can put yourself in the best possible position to secure a low-interest rate a home loan.
Don’t know where to start with improving your credit score? Check out this comprehensive guide for additional guidance.
The Bottom Line
Thanks to the wide variety of federal and private loan programs, it’s easier than ever to get approved for a mortgage even if you don’t have perfect credit. Of course, a higher credit score, minimal debt load, and steady source of income will strengthen your approval odds and make the process easier. But if you have a few more hurdles, there are still viable options to choose from if you’re willing to do the legwork to find a lender that’ll work with you.