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A lot of people have the misconception that in order to get approved for a mortgage loan, you need to have excellent credit. Normally, banks and mortgage lenders will approve applicants who have a credit score of at least 640. It is still possible to get approved for a home loan if you have a score below 600, but scores this low are considered bad credit and that means you will have higher interest payments. You may have some questions in mind on what to do if you have bad credit and are shopping for a mortgage. Before I dive into how bad credit affects mortgage loans, let’s learn a little more on the types of mortgage loans available.
Do the words conventional loans and FHA loans sound familiar? That’s because these are the two main types of mortgage loans. Conventional loans are issued by private lenders and are not secured by a government agency. FHA loans are also issued by private lenders but are guaranteed by the Federal Housing Administration. If your credit score is 620, you may get approved for a conventional mortgage offered by some private lenders. There’s a possibility that they will approve those with even lower credit scores, but it will be much more difficult to get approved and you may need to go into detail about your credit history. For FHA loans, some lenders will approve those with a credit score as low as 580, with 3.5% in equity. Some borrowers with scores as low as 550 may also be approved but with a catch, you’ll need at least 10% equity. With that being said, not every lender will approve someone with a bad credit score because it all depends on their tolerance for risk. If you have bad credit, lender’s will see you as a risky borrowers who may end up not paying the loan.
So, what should you keep in mind if you have bad credit and need a mortgage?
If you have a score below 620, it’s a good idea to work on improving your score before you start the process of looking for a mortgage. Having a score of at least 620 will not only give you a better chance of being approved, but you will also have access to better rates and terms. You will also avoid the scrutiny that comes with having low credit scores. By disputing errors on your credit report, paying down credit card balances and getting delinquent accounts back in good standing, you should be able to improve your score.
If you qualify for a down payment assistance program, you will have access to money to use for a down payment. Borrowers usually need a credit score above 620 to qualify. Most banks and lenders will provide down payment assistance of 5% of the home value for those with credit scores above 661. So, if your score is not doing so well, you will miss out on this assistance program.
3. Previous Foreclosures, Short Sales or Bankruptcies May Impact Your Approval Having a foreclosure, short sale or bankruptcy on your credit report may make it more difficult for you to get a mortgage loan. If you’ve been through a foreclosure or short sale, there’s a three-year waiting period, also known as a “seasoning period” before you can qualify. If you have a bankruptcy, the waiting period is two years. However, some loan programs may have shorter seasoning periods such as VA loans, which can get approved two years after a foreclosure.
With an FHA loan, your debt-to-income ratio can exceed 54% if your credit score is above 640. But you may still qualify if your score is just a few points below that. However, if you have a credit score of less than 600, it will be very difficult to get approved if your debt-to-income ratio is more than 45%.
Just because you may be eligible to get approved for a mortgage with bad credit, you should take a look at your financial situation and decide if it’s the best move. Before you start shopping for a mortgage, improve your credit score, lower your debt-to-income ratio and pay down your debt. Make sure to speak with your future lender or mortgage broker about any questions you may have to find the best deal for you.