Many home buyers, especially first time buyers, have less than great credit, and believe that a low credit score will make it very difficult, if not impossible, to get a mortgage and purchase their dream home. A survey conducted by Experian showed that one-third of buyers believe that bad credit will prevent them from buying a home, and 45 percent of those surveyed said they would delay purchasing a home because of bad credit, with 20 percent planning to wait at least five years. So, clearly a lot of potential home buyers believe they cannot buy a home if they have bad credit.
This is usually not true.
It is not impossible, or even that difficult, to get a mortgage with bad credit because there are financing options available for home buyers with low credit scores.
The first thing home buyers must do is find out what their credit score is:
Before you can explore your loan options, you need to assess what shape your credit is really in, says Todd Sheinin, a mortgage lender and chief operating officer at New America Financial in Gaithersburg, MD. For starters, credit scores range from 300 to 850, and are calculated based on the following factors:
- Payment history: 35%
- Debts owed: 30%
- Length of credit history: 15%
- Types of credit you have: 10%
- Applications for credit: 10%
By law, you’re entitled to a free copy of your credit report once a year from each of the three major credit bureaus: Equifax, Experian, and TransUnion.
Home buyers can get a free credit report at AnnualCreditReport.com, which will show credit history, but a small fee needs to be paid to see the actual credit score.
The credit score will give a home buyer, and their Realtor, a good idea of the options available for obtaining a mortgage.
If your credit score is 760 or above, you’re considered a low-risk borrower—meaning you’re likely to get the best interest rates and terms when you apply for a loan. Meanwhile, a good score is from 700 to 759, a fair score is from 650 to 699, and credit scores below 650 are deemed poor.
If your credit score is below 650, you may want to step back and take a few months to raise your score. But if you’re looking to buy a home right away, you do have options.
So, what are the options if your credit is not so great?
First Option: FHA Loan
The FHA loan is a mortgage that is issued by a federally qualified bank or financial institution. It differs from a conventional loan because it is insured by the federal government, which gives greater security to banks and mortgage companies that are taking on greater financial risk by lending to those with lower credit.
However, there is an extra cost to home buyers who decide to go the FHA home loan route.
But that security comes with a cost for the buyer: With FHA loans, the buyer must pay a 1.75 percent upfront mortgage insurance premium at closing, regardless of the down payment. Then, the buyer must make monthly mortgage insurance payments for the life of the FHA loan if the down payment is less than 10 percent. It can be canceled after 11 years if the down payment is 10 percent or more.
FHA borrowers will generally need at least a FICO credit score of at least 580 to qualify, although with a score between 500-579 a FHA loan can often be obtained if the borrower can come up with a down payment of at least 10 percent.
FHA borrowers also must pay a mortgage insurance premium.
Because FHA loans are government-insured, borrowers must pay an upfront mortgage insurance premium. Currently the fee is 1.75%—that’s $5,250 on a $300,000 home loan. Borrowers will also have to pay annual mortgage insurance, currently around 0.85% of the borrowed loan amount—or $2,550 more per year. Also, FHA loans are usually capped at $417,000. (In certain high-cost areas, the limit is $625,000.)
Second Option: VA Loan
The VA loan is for active and retired military individuals. A home buyer can get a VA loan with a credit score of 620 and below, and there is NO down payment required and there is NO mortgage insurance premium required, along with pretty good interest rates.
Third Option: 15-Year Fixed Loan
A credit score of at least 620 is usually required for a home buyer to get a conventional loan, but if you are are close to or at 620 then you are going to pay a higher interest rate.
But there is a way around paying a higher interest rate, according to Heather McRae, a senior loan officer at Chicago Financial Services. She says that “If you get a 15-year fixed loan, the lender will essentially turn a blind eye toward your credit score with respect to what interest rate you get.”
So, if you get a 15-year fixed loan, the lender will likely give you the same interest rate as if you had a credit score of 620-750.
Fourth Option: Make A Larger Down Payment
A lot of lenders will be more willing to give you a mortgage with a larger down payment.
Why? Because “the more you put down, the more you minimize the risk to the lender,” says Todd Sheinin, a mortgage lender and chief operating officer at New America Financial in Gaithersburg, MD. So, by increasing your down payment to 25% or 30% on a conventional loan—instead of the standard 20%—you’ll strengthen your mortgage application. Just bear in mind your credit score can still negatively affect your loan’s interest rate.
The key for you – the home buyer – to getting approved for a loan is to know exactly what your credit picture is early on, so that you will know what lending options are available to you well ahead of applying for a home loan. Most in the lending industry recommend checking your credit, fixing errors, and cleaning up the credit report, at least 90 days before applying for a home loan.
Doing this will likely save you time, money, and lots of stress.
Are you searching for your dream home in the Greater Las Vegas Valley? Looking to sell your existing home?
Then contact Rick Edwards and let’s get started today. Rick will get you results!