For prospective borrowers with less-than-perfect credit, getting approved for a mortgage isn’t guaranteed. But while it’s true that mortgage restrictions have tightened in recent years, there are still paths to home ownership for those who can improve their credit scores and do a little extra legwork.
Determining how you’ll be evaluated by lenders starts with your credit report and credit score. Everyone is entitled to one free credit report each year, provided by the credit reporting agencies Equifax, Experian and TransUnion, and obtainable at annualcreditreport.com.
Prospective borrowers with scores above 620 can typically find mortgage approval with at least one lender, although more selective lenders may restrict approval to scores of 660 and higher.
Generally, speaking the higher your credit score, the lower interest rate will be. If you have the time (and determination) to raise your credit score before buying a home, waiting could potentially save you thousands over the full term of a mortgage.
The Federal Housing Administration (FHA) provides program support for aspiring homeowners with low credit scores, but there’s still a limit to what they’re able to do if you have a checkered credit history.
Technically, FHA allows loans for borrowers with credit scores as low as 500, but there are additional restrictions. For example, unresolved instances of bad credit can stop those mortgages, and borrowers are generally required to maintain good credit for at least 12 months leading up to the loan. As a result, most borrowers with scores below 600 are ultimately denied.
The best strategy for borrowers in the 500s is to raise their credit scores by establishing and maintaining a pattern of on-time bill payment for several consecutive months. Credit card debt should be minimized and applications for new credit accounts should be avoided.
Bad credit can occur due to circumstances beyond our control, or simply from incomplete financial education. Lenders understand this. If you can establish that a blemished credit record is the result of an unavoidable loss of income, a prolonged illness or other extenuating circumstance, that may influence mortgage approval in your favor with either FHA or individual lenders.
As for beefing up your knowledge of personal finance and home buying, the U.S. Department of Housing and Urban Development (HUD) provides free counseling at offices around the country to educate and advise on matters of credit, mortgages and other aspects of home buying. You can find your nearest office here.
In addition to your credit score, pay attention to your debt-to-income ratio -- that’s your monthly debt payments divided by your monthly gross income. For example, if your total monthly credit debts are $1,000 and your pre-tax monthly income is $5,000, your debt-to-income ratio is a healthy 20%.
The important cut-off point for debt-to-income ratio is 43% -- any higher, and you’ll have a hard time securing a qualified mortgage, according to the Consumer Financial Protection Bureau. If you’re above this threshold, focus on paying down debt before filing mortgage applications.
You may be surprised at the level of help lenders may offer if you ask, and you can always turn to your nearest HUD office for advice and assistance.
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