Although most lenders prefer a 20-percent down payment and an excellent credit score before lending you money to purchase a home, many potential buyers aren’t in that position. Luckily, you still have options, even if you have less-than-perfect credit.
One major factor that determines your eligibility for a home loan is your credit score. A decade ago, when lenders lowered credit-score requirements and awarded hundreds of billions of mortgage dollars to subprime borrowers, a housing bubble grew, popped, and sent the nation straight into the Great Recession. Since then, lenders have become much more modest in their lending, primarily requiring and relying on high credit scores to award home loans.
Luckily, home-loan access could be changing, and in the meantime, there are still options—even with a credit score that is less than stellar.
Access Could Be Changing
Today, major lenders like Fannie Mae and Freddie Mac rely on FICO scores, which are created by Fair Isaac Corp. and have been the standard for decades. However, FICO scores tend to be much more modest than those reported by the well-known credit-reporting firms TransUnion, Equifax Inc., and Experian PLC. Non-bank lenders are pushing to be able to use the scores reported by these three companies in evaluating home-loan applications in order to increase the borrower pool and increase the amount of mortgages awarded.
Sanjiv Das, CEO of a major nonbank lender, said using FICO alternatives could be a huge boon to countless potential home owners, including millennials, who often don’t have a substantial credit history. “I strongly believe that a large number of customers are being excluded because of the slavish reliance on FICO,” he said.
Whether lenders will be able to use TransUnion, Equifax, and Experian credit scores going forward remains to be seen, but such a trend could vastly change the number of people who are able to get home loans more easily, so there’s reason to stay optimistic.
What Lenders Are Looking For
Lenders start by looking at your FICO credit score to see which types of home loans you qualify for. It’s important to note that the lower your credit score, the higher your home-loan interest rate will be. Next, lenders look at a complete credit history to assess what will come up in the underwriting process. Underwriting is a process by which a lender tries to determine what has happened in your credit history—and whether your history is likely to repeat itself.
Negative items in your credit history will work against you, so be sure to obtain a copy of your free credit report and make sure everything reported is accurate. Even those with the best credit can be blindsided by something in their credit history they didn’t know about. Too many accounts, missed payments, revolving credit of more than 30 percent, and other negative patterns can do additional damage to your image in the eyes of a lender, on top of a low credit score.
On the other hand, many lenders will reach out and ask for a letter of explanation about questionable items on your credit report, so be prepared to explain. For example, if you quickly acquired a chunk of debt, a lender might ask why. Explaining that you lost a job and the debt came from paying for daycare that afforded you the time to apply and interview for jobs could sway a lender—especially if you’re now gainfully employed.
Home Loan Options for You
Bearing all of this in mind, you may want to look into these home-loan options that are within your reach, even with less-than-perfect credit:
If you have good credit, a conventional loan will be easy to come by, even with the required down payment of 3 percent. However, if you can offer a sizeable down payment (larger than the standard 20 percent), even with imperfect credit, you could still be approved for a conventional loan.
Veterans Administration (VA) loans are only available to U.S. military personnel, veterans, and their spouses. If you’re eligible, no down payment is required, but lenders do typically look for a FICO score of at least 620 (but some will consider a score of 580).
For many with less-than-perfect credit, a government-backed Federal Housing Administration (FHA) loan is the best option, but be aware that they can come with higher down payment and other expenses. Here are some of important details about FHA loans:
- In order to qualify for a 3.5-percent down payment, you must have a FICO score of 580.
- If your FICO score is lower than 580, you could still qualify, but you would be required to put down at least 10 percent to qualify.
- FHA loans claim to have lower interest rates, closing costs, mortgage insurance, and more—even for borrowers with lower FICO scores.
- Although the FHA require two lines of credit in order to qualify for a home loan, it allows applicants to submit alternative forms of credit, such as proof of utility or rent payments.
One of the most important things to know about an FHA loan, however, is that making a down payment of less than 20 percent means you’ll be required to purchase mortgage insurance, which protects the lender. Also, you should take time to consider how much house you can afford and check the FHA Mortgage Limits calculator to see what the home-loan limits are for your geographical area, so you can realistically approach your home-buying journey.
Make It Happen
Working with the right home-loan consultant, you’ll be able to find the right loan to meet your monthly budget and down-payment needs. That way, you’ll be able to focus on your ideal home, not the details. Get started today with our Mortgage Calculator and see how you can get a home loan.