A low credit score doesn't have to lock you out of home ownership. A mortgage will probably cost you more (both in dollars and angst) than it would for someone with stellar credit, but many lenders are willing to work with you.
Here's what you need to know about low-credit score mortgages:
What Counts as "Low Credit" Anyway?
First, let's debunk the home-buying myth that you have to have a gold-plated credit score to buy a house. Lenders review your whole financial picture. If you have a steady income, a regular payment history, and some cash in hand, that will help balance your less-than-perfect credit.
Here's how FICO generally categorizes credit scores:
- 800+ = Exceptional credit score
- 740-799 = Very good credit score
- 670-739 = Good credit score
- 580-669 = Fair credit score
- Below 580 = Poor credit score
A credit score of 669 or below typically makes you a "subprime" borrower, according to FICO. That means you're a bigger risk, so loans will cost more, and your options will be limited.
Your primary low-credit-score mortgage option will be FHA , which will issue loans with credit scores as low as 580 with a down payment of 3.5%. If you can increase your down payment to 10%, you can qualify with a credit score of 500. So, the lower your score, the more it will cost you.
A positive change is in the works that intends to make credit scores more inclusive and accurate. Instead of using only the classic FICO, the Federal Housing Finance Agency approved adding two alternative scoring models that Fannie Mae and Freddie Mac will use. These alternative models will consider credit factors such as payment of utility and cell phone bills, and rent, expanding mortgage access to more credit-worthy home buyers, according to MarketWatch.
How Does Your Credit Score Affect Interest Rates?
You may pay more in the form of a larger down payment, a higher interest rate, private mortgage insurance, or points, which are fees attached to the loan.
How much more interest might you pay? Let's say you're going for a $216,000, 30-year, fixed-rate mortgage. Here's how your rate could change based on your score. (FYI, the monthly payment estimate includes only interest and your principal, not insurance, taxes, private mortgage insurance, or other expenses.) Rates here may not reflect current conditions.
|
If your FICO score is… |
Your interest rate is… |
And your monthly payment will be… |
|
760 - 850 | 2.835% | $1,238 |
|
700 - 759 | 3.057% | $1,274 |
|
680 - 699 | 3.234% | $1,303 |
|
660 - 679 | 3.448% | $1,338 |
|
640 - 659 | 3.878% | $1,411 |
|
620 - 639 | 4.424% | $1,507 |
|
Source: FICO |
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Buy Now Or Work On My Credit?
That's a good question and one only you can answer. If your rent is astronomical, it might be better to own sooner and refinance when your credit improves. For others, it may be smart to . A lender can help you decide. Or you can use an online tool to estimate the cost of different scenarios.
If you're going to apply for a low-credit-score mortgage, more cash in the form of a bigger down payment helps. Plus, it can reduce your interest rate, which reduces your monthly payment.
"My recommendation for any client would be wait and save toward a bigger down payment," says Melissa Finnell, producing sales manager for bank Truist, previously BB&T. "A lower loan-to-value ratio offsets a higher interest rate, and this gives clients time for their credit to rehabilitate, too."
How Do I Boost My Credit Score?
If you opt to work on your credit before getting a mortgage, here are a few ways to do it:
- Look into rapid rescoring. You'll work through your lender to fix errors and update information with the credit bureaus quickly, sometimes within days or weeks rather than months. This isn't credit repair, but a way to accelerate getting updated information through the system and into your report. Discuss with your lender whether this is a worthwhile pursuit for your circumstances.
- Find a reputable credit counselor to guide you, because scams are common in the industry. Start with the National Foundation for Credit Counseling and the Financial Counseling Association of America, each of which has local member agencies that adhere to credit counseling standards.
- Check your credit report for errors.
- Pay off credit card balances.
- Pay off other outstanding collections.
- If you don't have credit, get a credit card or small loan and establish a good payment history. (No credit is low credit.)
Even if you have a low credit score, a mortgage isn't out of reach. While it may cost you more to buy now, in the end, it may be less expensive than waiting. And you'll get the joy of owning a home to call your own.
Related: Little-Known Ways to Get Down Payment Help