January 19, 2021

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7 best home loans for people with bad credit (starting at 500 FICO)

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What’s the minimum credit score to buy a house?

Home buyers are often surprised at the range of low credit home loans available today.

Most lenders will issue government-backed FHA loans and VA loans to borrowers with credit scores as low as 580. Some even start at 500-579 (though these lenders are harder to find). 

With a credit score above 600, your options open up even more. Low-rate conventional mortgages require only a 620 score to qualify. And with a credit score of 680 or higher, you could apply for just about any home loan.

So the question isn’t always “can I qualify for a mortgage?,” but rather “which one is best for me?”

Find the right low credit home loan for you (Jan 3rd, 2021)


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Compare low credit score home loans

Some mortgages are
specifically designed to help lower credit applicants get into homes. Here are
seven different options that may work for you:

Mortgage TypeMinimum Credit Score Recommended For
FHA Loan500 (with 10% down)
580 (with 3.5% down)
Borrowers with credit scores from 500-620
VA Loan580-620 (varies by lender)  Eligible veterans and servicemembers
USDA Loan640Buying a house in a rural area
Conventional Loans620Borrowers with moderate to good credit
Freddie Mac Home Possible620Low- to moderate-income borrowers
Fannie Mae HomeReady620Low- to moderate-income borrowers
Non-qualified (Non-QM) Mortgages500-580Borrowers who don’t qualify for a conventional or government-backed loan

Find the right low credit home loan for you (Jan 3rd, 2021)

The 7 best mortgage loans for bad credit borrowers

1. FHA mortgage: Minimum credit score 500

FHA loans — backed by the Federal Housing
Administration — have the lowest credit score
requirements of any major home loan program.  

Most lenders offer FHA loans starting at a 580 credit
score. If your score is 580 or higher, you only need to put 3.5% down.

For those with lower credit (500-579), it might still be
possible to qualify for an FHA loan. But you’ll need to
put at least 10% down, and it can be harder to find lenders that allow a 500
minimum credit score.

Another appealing quality of an FHA loan is that, unlike conventional loans, FHA-backed mortgages don’t carry risk-based pricing. This is also known as “loan-level pricing adjustments” (LLPAs).

Risk-based pricing is a fee assessed to loan applications
with lower credit scores or other less-than-ideal traits.

There may be some interest rate “hits” for lower-credit FHA borrowers, but they tend to be
significantly less than the rate increases on conventional loans.

For FHA-backed
loans, this means poor
credit scores don’t necessarily require higher interest rates.

Verify your FHA loan eligibility (Jan 3rd, 2021)

2. VA mortgage: Minimum credit score 580-620

VA loans are popular mortgage loans offered to
veterans, service members, and some eligible spouses and military-affiliated borrowers.

With
backing from the Department of Veterans Affairs, these loans do not require a down payment, nor any ongoing mortgage
insurance payments. They also typically have the lowest interest rates
on the market.

Technically, there’s no minimum credit score requirement for a
VA loan. However, most lenders impose a minimum score of at least 580. And many start
at 620.

Similar to FHA loans, VA loans don’t have risk-based
pricing adjustments. Applicants with low scores can get rates similar to those
for high-credit borrowers.

Verify your VA loan eligibility (Jan 3rd, 2021)

3. USDA home loan: Minimum credit score 640

USDA
loans are popular for their zero down payment requirement and low rates.

You’ll typically need a 640 FICO score to qualify for
a USDA loan, though minimum credit score requirements vary by lender.

These
mortgages are backed by the U.S. Department of Agriculture with the goal of
increasing homeownership in rural areas. To qualify, you must buy a home in a
qualified “rural” area — though some suburbs make the cut.

A USDA loan
also won’t work if you make too much money. Your household income can’t be more
than 15 percent higher than the median household income in your area.

Verify your USDA loan eligibility (Jan 3rd, 2021)

4. Conventional loans: Minimum credit score 620

Non-government conventional mortgage loans charge higher
interest rates and fees for
borrowers with low
credit scores.

Fannie Mae and Freddie Mac, the agencies that
administer most of the conventional loans in the U.S., charge loan-level price
adjustments, or LLPAs.

These fees are based on two loan factors:

  • Loan-to-value
    (LTV): the ratio between the loan amount and home value
  • Credit
    score

As LTV rises and credit score falls, the fee goes up.

For instance, a borrower with 20% down and a 700
credit score will pay 1.25% of the loan amount in LLPAs.

An applicant with a 640 score and 10% down
will be charged a fee of 2.75%.

These
fees translate to higher interest rates for borrowers. That means lower-credit
score applicants will have higher monthly payments and pay more interest over
the life of the loan. 

The majority of lenders will require homeowners to
have a minimum credit score of 620 in order to qualify for a conventional loan.

But although conventional loans are available to
lower-credit applicants, their fees often means FHA loans end up being cheaper
for borrowers with bad credit scores.

Verify your conventional loan eligibility (Jan 3rd, 2021)

5. Freddie Mac Home Possible: Minimum credit score 620

Released in March 2015, Freddie Mac’s first-time home
buyer program, Home Possible, is helping buyers get into homes with a
very low down payment and moderate credit.

Home Possible is available for low and moderate-income borrowers and allows for a down payment of just 3%.

To qualify for the Home Possible loan with reduced private mortgage insurance (PMI) rates, most lenders will require a 620 or better credit score.

Verify your Home Possible loan eligibility (Jan 3rd, 2021)

6. Fannie Mae HomeReady: Minimum credit score 620

Released in December 2015, HomeReady is a great
Fannie Mae loan program for low- to moderate-income borrowers, with expanded
eligibility for financing homes in low-income communities.

Unlike Freddie’s Home Possible program, you don’t
have to be a first-time homebuyer to qualify for HomeReady.

Along
with its 3% minimum down payment requirement, this loan type has another
attractive feature: Underwriting can include income from other people in your
household, regardless of their credit history.

Rather
than basing your debt-to-income ratio only on your monthly income and your
co-borrower’s income, the DTI ratio can include the income of your roommates, adult
children, or parents who happen to live with you.

Most lenders require a minimum credit score of 620 to
qualify for HomeReady.

Verify your HomeReady loan eligibility (Jan 3rd, 2021)

7. Non-qualified mortgage (Non-QM): Minimum credit score 500-580

The qualified mortgage rule, also known as the QM
Rule, went into effect in 2014.

The requirements associated with QM loans were set by
the federal government. These rules are designed to create safer loans by
prohibiting or limiting certain high-risk mortgage products.

This rule is the reason most loans require a minimum
credit score in the 600s as well as a down payment and/or private mortgage
insurance.

But there are still some “non-QM” loans available
that have more flexible rules. 

When banks don’t sell their mortgages to investors,
they’re free to set their own criteria — like lower minimum credit
score requirements.

Thus, some non-QM loans can be found with credit
scores as low as 500. But like with an FHA loan, you’re much more likely to
find a lender who will approve you with a FICO score of 580 or higher.

If you’re looking for one of these loans, check out
the specialty mortgage programs some banks offer that are neither conventional
loans nor government-backed.

Or, work with a mortgage broker who can recommend products from various lenders that might fit your needs.

Tips to improve your credit report before home buying

Bad
credit doesn’t necessarily mean you won’t qualify for a mortgage. But borrowers
with good or excellent credit have the most loan options. They also benefit
from lower rates and fees.

If you’re
able to polish up your credit report before shopping for a mortgage, you’re
more likely to qualify for the best loan terms and lowest interest rates.

Here are
a few tips to improve your credit report and score before applying.

  • Lower your credit utilization — Paying down your credit cards and personal loan balances lowers your credit utilization ratio, which lenders like to see. This also helps your debt-to-income ratio. Credit utilization is your credit card balance compared to your limit. Someone with a $10,000 credit limit across all cards, and a $7,000 balance has a utilization ratio of 70%. This is too high. Pay down balances to 30% or less to see the biggest credit score improvement
  • Improve your payment history — Late payments and missed payments will pull down your FICO score. Be sure to make on-time payments on all your loans and credit cards
  • Check your credit report for accuracy — The three major credit bureaus — Experian, Equifax, and Transunion — make mistakes sometimes. Your creditors can report inaccurate information to the credit bureaus, too. Monitor your own credit history so you’ll notice errors before they pull down your score. The government has set up a website where you can check your credit accounts free: annualcreditreport.com
  • Dispute inaccurate information — If you do find inaccurate information in your credit history, be sure to file a dispute — especially if the errors include huge blemishes like foreclosures, repossessions, or collections accounts

Removing
inaccurate information can increase your credit score quickly. Developing
better credit habits will take longer to produce results.

If you
discovered problems in your credit history after applying for a mortgage loan,
it may be too late to increase your credit score. If you continue the home
buying process, expect a higher monthly payment — especially on a conventional
loan.

But you may be able to refinance your mortgage in a few months or years after your credit score improves.

Refinancing could help you replace your existing mortgage with a new one that has a lower rate and better terms, once your finances are looking better. 

Bad credit mortgage FAQ

What credit score is considered bad credit?

Credit bureau Experian doesn’t use the term “bad credit,” but it does consider any score below 580 “very poor credit.”

Average credit scores range from 580-669; good credit scores begin at 670. If your credit score falls below 580, you’ll notice fewer loan options are available. Many lenders consider FICO scores below 580 to be “subprime” territory.

Can a cosigner help me get approved?

Yes, a cosigner with a good credit history could help you secure a loan, assuming your lender allows cosigning.

However, this is a big ask since the mortgage loan would affect your cosigner’s ability to borrow for his or her own needs. Plus, your cosigner would be on the hook for your mortgage payments if you can’t make them — and in the event of foreclosure or even late payments, their credit would take a huge hit.

Most home buyers prefer co-borrowing with a spouse or partner. Co-borrowers become co-owners of the home and share in its equity.

Will a bad credit mortgage require higher closing costs?

While there’s not necessarily a direct correlation between lower credit scores and higher closing costs, borrowing with bad credit does limit your loan options, which can lead to higher borrowing costs.

For example, let’s say you have a FICO score of 510 and can find only one lender willing to approve your FHA loan. If that lender charges a higher-than-average loan origination fee, you won’t have the option of shopping around for lower fees from other lenders. 

Does mortgage insurance cost more when you have bad credit?

Yes, bad credit will affect how much you pay in private mortgage insurance on a conventional loan.

For FHA loans, your credit score will not affect mortgage insurance premium rates. However, your credit score will affect your down payment requirement. You’d need a 10% down payment on an FHA loan with a credit score below 580.

Ironically, meeting this 10% down payment because of your bad credit score could help you save on mortgage insurance premiums (MIP). Why? Because borrowers who put 10% down pay MIP for only 11 years instead of for the life of the loan.

How do mortgage lenders afford bad credit loans?

Unlike personal loans and student loans, mortgages are secured loans. This means the lender could seize your home and sell it to offset its losses if you stopped making monthly payments. This security helps lenders offer lower rates than unsecured lenders when borrowers have lower credit scores.

FHA, VA, and USDA loans have an additional level of protection: backing from the federal government. That’s why you could still get an FHA loan, for example, even with a credit score below 580, which most lenders consider subprime lending. 

Should I improve my credit score before buying real estate?

This is up to you. Since real estate tends to appreciate in value, buying into the housing market now means you could capitalize on rising real estate prices which could offset some of the higher costs of borrowing with poor credit.

However, keep in mind there’s no guarantee your house will increase in value.

Today’s remarkably low interest rates have also created an incentive for home buying and refinancing now rather than waiting. Of course, if your credit score is too low to get a mortgage approval of any kind, you’ll definitely need to work on your credit report before borrowing.

What are today’s mortgage rates?

Even if you have a lower credit score, there’s a good chance you can still get a low rate and payment in the
current interest rate market.

Check your eligibility for one of today’s
credit-friendly mortgage programs.

Verify your new rate (Jan 3rd, 2021)

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