Most of us are aware of how important our credit score is in securing any type of credit - be it a home loan, car loan, or credit card. Unfortunately, one of the more pervasive myths that prevent people from owning homes is the idea that you can't get a mortgage with a low credit score. That is simply not true unless you are at the lowest end of the credit score scale. Otherwise, there will be banks and mortgage lenders willing to work with you to make your dreams of homeownership possible.
Before we go any further however, it's important that we define the credit score. Your credit score is not the same thing as your credit report despite what you may have been told in the past. Your credit score is a measurement of how risky you are as a borrower. It's represented typically in a number between 300 and 850, based on the FICO system used by most mortgage lenders. The higher your number is, the less likely you are to default on a loan; the opposite is also true.
This number is produced by running all of the information from your credit report through a mathematical formula developed in the 1960s by an engineer and mathematician. Statistically speaking, the mathematical formula is fairly accurate in predicting how likely an individual is to be more than 90 days late on loan payments. Because of its accuracy FICO is the scoring method of choice for mortgages and other high value loans.
Mortgages with High Credit Scores
It's a given that individuals with high credit scores are going to have an easier time getting a mortgage. Based on the FICO system, a score above 700 is considered "prime" and is eligible for the best interest rates, the easiest terms, and the most mortgage options. If you have a credit score this high you'll be able to get a conventional loan without any trouble. Scores under 700 are more likely to qualify for FHA loans rather than conventional loans.
Mortgages with Low Credit Scores
Believe it or not, the Department of Housing and Urban Development (HUD) will allow FHA loans to be approved for anyone with a credit score of 500 or better, provided certain conditions are met. HUD does not make these loans themselves, but they do guarantee the banks that issue them will be covered in case of default. When the holder of an FHA mortgage defaults HUD forecloses on the property, pays off the bank, and then sells the home on the open market. The backing provided by HUD makes banks more comfortable in lending to people with low credit scores.
All of that said, the closer you are to that 500 threshold the more difficult it's going to be for you to get a mortgage with friendly terms and interest rates. Just like a prime credit score gives you better rates and terms, a higher score in this range affords the same benefits. In other words, you'll do better with a score of 625 than you will with a score of 525. So even though it's possible to get a mortgage with a score above 500 you won't necessarily be able to find one that's reasonably attractive.
Considering Whether or Not It's Worth It
If you're considering purchasing a home with a low credit score you must ask yourself whether or not the terms and rates are worth it to you. Right off the bat, let's just admit the fact that if your credit score is below 500 you are not a candidate for a home loan. You might just as well continue renting and do everything you can to improve your credit score before applying for a mortgage. For those in the 500 to 600 range, you need to consider some of the same things.
For example, if a score of 525 means your interest rate on a 30-year, fixed-rate mortgage is going to be 8.5%, is it worth it to you to pay such high interest if you could wait three years and take that time to rebuild your credit? Maybe not if you consider the fact that a credit score of 700 might get you an interest rate of 5%. That difference of 3.5% can mean the difference between tens of thousands of dollars paid in interest over the life of a 30-year mortgage. Is it worth it to pay that much interest just so you can purchase a home today?
If you can take the next few years and increase your credit score to 700 the amount of potential savings is very significant. What it comes down to is whether or not your need for homeownership is absolutely pressing. Truth be known, it's not for most people. The problem is it's very difficult to repair such poor credit for most people because they lack the self-discipline to do so. That lack of self-discipline is what landed them in hot water to begin with; getting out of the position of poor credit requires that lack of self-discipline to change.
Check Your Score before Beginning to Look for a House
In order for you to make a decision as to whether or not it's worth pursuing a mortgage, you should check your credit report and score before you even begin looking for a house. You can get a free copy of your credit report once every 12 months from the nation's big three credit reporting companies: Experian, Equifax, and Trans Union. As for your credit score, you'll have to pay a nominal fee to get a copy of that. But with both your credit report and credit score in hand you'll be better positioned to decide whether or not to purchase a home.
Checking on your credit report before hand also gives you the opportunity to correct any mistakes that might appear in the report. Keep in mind that the information on the report is what is used to determine your credit score. If you find any inaccuracies you need to contact the reporting agency and deal with them immediately. Getting rid of inaccuracies will raise your credit score and possibly put you in a better position to get a mortgage.
In conclusion, it is possible to get a low credit score mortgage. It's just that it might not be worth it to you depending on your circumstances and how low your credit score is. If your score is low enough, you may want to wait a few years and rebuild your credit before applying for a home loan.