If you have less than perfect credit, you may wonder if you have a chance to secure a mortgage. Don’t you need perfect credit for lenders to approve your loan request?
Luckily, you don’t need perfect credit to secure a mortgage. The government-backed loan programs make it easy to secure the approval you need, even with bad credit scores. Just what credit scores do you need and how do the government loan programs work? Keep reading to find out more.
FHA Loans – A Great Choice
Many borrowers that can’t secure conventional financing turn to FHA loans. While the loan program has the stigma of being a ‘first-time homebuyer’s loan’ that’s not the case any longer. The FHA loan is a great option for anyone that can’t secure traditional financing.
The best news about the FHA loan is that you only need a 580 credit score. On a traditional credit rating scale, that’s a ‘fair’ credit rating. Most loan programs would turn you away, but the FHA loan program doesn’t. As long as you can find a lender willing to accept your 580 credit score, you can secure FHA financing.
The other qualifying factors you need for the FHA loan include:
- Maximum 31% housing ratio – Your housing payment shouldn’t exceed 31% of your gross monthly income (this includes principal, interest, real estate taxes, homeowners’ insurance, and mortgage insurance).
- Maximum 41% total debt ratio – Your total debt payments (credit cards, student loans, mortgage, car payments, and installment loans) shouldn’t exceed 41% of your gross monthly income.
- Stable income and employment – You should have a solid history of stable income at the same employer or within the same industry if you’ve changed jobs recently.
- A 3.5% down payment – You only need to come up with 3.5% of the purchase price of the home for your down payment. In addition, 100% of these funds can be gift funds from a relative or employer (not a loan).
- No bankruptcies in the last 2 years – If you filed for a Chapter 7 bankruptcy, you must wait at least 2 years from the discharge of the BK before you can apply for an FHA loan.
- No foreclosures in the last 3 years – If you lost your home in a foreclosure, you must be at least 3 years out from the date you lost your home.
The only other requirement is that the home you purchase must be for owner-occupancy. You can’t use the FHA loan program to purchase a vacation home or an investment home.
VA Loans – A Viable Option for Veterans
If you served in the military for at least 181 days during peacetime or 90 days during wartime and had an honorable discharge, the VA loan could be a good option even if you have bad credit.
The VA doesn’t have a minimum credit score that you must have in order to secure your VA loan. On average, VA lenders want a 620 credit score, but the VA lets its approved lenders decide what credit score they require. This means you may find lenders that will accept your ‘bad’ credit score as long as you meet the other VA guidelines and have compensating factors.
The VA guidelines are simple:
- Stable income and employment – You must be able to prove that you can afford the loan and that you aren’t a high risk of default. A 2-year employment history at the same job with consistent income is usually the key to approval on a VA loan.
- Maximum 41% total debt ratio – Your total debts (credit cards, installment loans, student loans, mortgage, and car payments) shouldn’t exceed 41% of your gross monthly income. The VA doesn’t have a maximum housing ratio requirement like FHA loans.
- No bankruptcies within the last 2 years – If you filed for Chapter 7 bankruptcy, you must be at least 2 years out from the discharge (not the date you filed).
- No foreclosures within the last 2 years – If you lost your home in a foreclosure, you must wait 2 years plus you must prove that you have enough entitlement to qualify for the VA guarantee (more on that below).
- Enough disposable income – The VA requires a specific amount of disposable income (money left over) after you pay your monthly bills. They base the amount you need on your family size and where you live.
As far as the entitlement goes, each veteran receives enough entitlement to purchase a home up to $484,350 with no down payment. If you lose a home in foreclosure, you lose the entitlement used to purchase that home. If you used $300,000 to buy the home, you only have $184,350 left in entitlement. You can use that entitlement to purchase a home after the foreclosure, but if you purchase a home for more than the amount of your entitlement, you’ll need to make a down payment.
USDA Loans – Not as Forgiving as the Other Government Loans
The only other government mortgage program is the USDA loan program and they require a 640 credit score. If you live in a rural area and have low to moderate income, you may qualify for this program, but you’ll need that higher credit score in order to qualify.
The USDA program does offer 100% financing, but they have stricter guidelines than the two programs listed above. If you plan to live in a rural area, it may be worth waiting until you can improve your credit score to 640 in order to get the 100% financing that the USDA offers.
The FHA and VA loans are great ways to get the financing you need despite having a lower credit score. You are free to use any FHA or VA-approved lender that you find. If you have a low credit score or other ‘risky factors’ shop around until you find a lender willing to give you the loan you need.