Many people who would like to be homeowners, or hope to refinance a mortgage that is costing them too much, worry that low credit scores will prevent them from qualifying for a home loan. It is important to learn the facts--even those with less than perfect credit can be approved for a mortgage. Those who do not meet the minimum score required can improve their credit rating so they will be approved in the future.
Minimum Credit Score Requirements
Lenders are cautious about lending to customers with blemished credit. The most common minimum credit score a mortgage lender will allow is 620, according to Michele Lerner with Bankrate, an online financial publisher. If other factors, such as a high loan amount or low down payment, make the loan more risky, the minimum credit score required may be higher.
Options for Borrowers With Lower Credit Scores
Mortgage programs exist with guidelines that will permit credit scores below 620. In general these are government-backed loans, meaning a government agency provides insurance that will pay the lender for any losses should the loan go into default. A few examples include FHA loans backed by the Federal Housing Authority, VA loans backed by the Department of Veterans Affairs and USDA mortgages backed by the US Department of Agriculture. Some states and local governments also offer similar programs.
How Credit Score Relates to Loan Pricing
The price a borrower pays to borrow money through a mortgage loan is based on the current market as well as the level of risk. Borrowers who lenders believe are most likely to repay the loan as agreed will receive the best pricing (lower interest rate and upfront fees) and those who are deemed more risky will have to pay more for the same loan. Most banks use automated computer programs to determine the risk level of a certain scenario. These programs use credit scores among other factors such as income, available assets, other debts and the amount of equity in the property to analyse risk.
Credit history is particularly important because it shows how well an individual has handled debt in the past. According to Experian, one of the three credit bureaus, "past payment history and use of credit" are the leading indicators of whether future debt payments will be paid on time and in full.
What if a Loan Is Denied?
When a loan application is not approved because of poor credit it can be "disappointing and discouraging," says Kelly Decker, Branch Manager for American Bank, a National bank offering mortgage lending. Decker insists that individuals in this situation "should not give up their dream of home ownership and should instead work to rebuild their credit."
With commitment and disciplined spending it is entirely possible to improve credit scores over time.
How to Improve a Credit Score
Sometimes scores are low because not enough credit history has been established. In this case a good place to start is to take out a credit card with a low limit. Charge small amounts to the card and always pay the bill on time every single month.
If low credit scores are the result of a financial rough patch when accounts became delinquent, work diligently to pay all obligations on time and in full. It is important to check through the credit report carefully to be sure there are no mistakes. Borrowers are frequently penalised for misreported information. The three credit bureaus, Experian, TransUnion and Equifax, outline the process for correcting mistakes on their websites.