So, you want to get a mortgage, but your credit score is not so good. There are probably more than a few questions swirling in your head right now. First, you're probably wondering, "Can I get a mortgage?" But soon after that, you may be thinking, "Should I buy a house at all?"
The reality is that it may indeed be possible for you to get a mortgage, but even if you can secure one, you need to understand the reality of obtaining a home loan with a sub-par credit score, as well as the extra steps you'll need to take to ink the deal.
Where to begin?
Expect to Pay a Higher Interest Rate
Like any other loan, lenders will usually charge you a higher interest rate on your mortgage if you have a lower credit score. Subprime borrowers generally have a credit score below 640. This group of borrowers has higher default rates and credit histories marked with higher delinquencies and credit utilization. (See also: What is a Good Credit Score?)
As such, lenders opt to charge these borrowers higher interest rates to protect them from the greater risks they are taking on to lend to this segment of the population.
Given the hefty size of most mortgages (the average mortgage balance was just under $200,000 as of 2016) and the long payment terms of 15, 20 or 30 years, that higher interest rate means you'll pay more interest and less toward your principal payment.
If you're set on getting a mortgage in the immediate future, your best bet is to check your credit and see if there are any actions you can take to bump up that score. A few credit score best practices include:
- Pay down your debts.
- Pay your bills on time.
- Dispute possible errors.
While you may be tempted to close accounts that you no longer use, beware. Closing accounts—even ones you don't use—can actually hurt your credit. First, mortgage lenders like to see accounts that have some history, so having old accounts is a good thing.
Second, credit scores are based in part on the amount of credit you have available versus what you actually use. This is known as your credit utilization ratio. So, if you close a credit card you don't use, you're effectively lowering the amount of available credit you have. Therefore,o it is probably better for you to pay off the debt, but keep the line of credit open.
Consider an FHA Loan
An FHA loan is a mortgage backed by the Federal Housing Authority, and it is a popular choice for first-time borrowers and those with low credit scores. Individuals who have credit scores of 580+ can get this loan with as little as 3.5% down, while those consumers with credit scores between 500 and 579 can secure a loan with a 10% down payment.
There are other requirements too, like having steady employment and getting an FHA appraisal, but this could be a good place to start for many subprime consumers. It's also important to note that the FHA mortgage comes with private mortgage insurance—also known as PMI—so, in addition to paying principal and interest, you'll be required to pay this insurance fee every month for a set period of years. It is an added layer of protection for the lender, in the event, you default.
If you're set on getting the loan now, and it's your only option, you can work on making steady payments, re-establish your credit and consider refinancing your mortgage in the years to come to ultimately work yourself into a more favorable loan.
Do The Hard Work Now and Postpone the Mortgage
Is it possible to get a mortgage with a low credit score? Yes. But just because you can, doesn't mean you should. This is not the answer most people want to hear, but if you have the time and can take some steps to improve your credit, a few months or short years can save you substantial money in fees and interest rates.
Credit scores can actually inch up quite quickly with consistent on-time payments, lowering debts and showing you can manage all of your credit lines wisely. You can keep close tabs on your credit and get guidance on which actions you can take to improve your score with basic credit monitoring products. And once that score goes up, you have more options to shop, more favorable rates and lower fees to address.
Home ownership is on the wish list for many Americans, but a mortgage is a substantial commitment—one of the largest loans most people will ever take out in their lifetimes. As such, it should not be taken lightly. Do your homework and understand the consequences of any route you elect to take.