A low credit score doesn’t necessarily mean you can’t get a mortgage loan, but at the same time, you shouldn’t expect the most favorable loan terms. Several mortgage products are available to borrowers with low credit scores. You only need a 620 credit score to qualify for a conventional mortgage, and you can get an FHA mortgage with a credit score as low as 500. But while you might have options, it is important to understand how bad credit affects your home loan terms.
Higher Mortgage Interest Rates
Although mortgage lenders have relaxed their guidelines and will approve borrowers who have low credit scores, this doesn’t mean “everyone” with bad credit qualifies for a home loan. The lender will check your credit history and review your income. If you have more than one to two late payments in the past 24 months, you may not qualify. There are also rules for qualifying for a mortgage after a bankruptcy and foreclosure. In the case of a foreclosure, you have to wait at least three years to get approved for an FHA home loan, and seven years for a conventional home loan.
But even if your recent performance demonstrates good credit habits and you’re approved for a loan, getting a mortgage with a low credit score means you’ll pay a higher interest rate than an applicant with good credit. For example, a borrower with an 800 credit score may qualify for an interest rate of 3.8%, whereas a borrower with a 640 credit score qualifies for an interest rate of 4.6%. If you’re looking to buy a home at $200,000 with a 30-year term, that’s a monthly difference of $93.
Bigger Down Payment Requirements
Down payments are required with a conventional mortgage and an FHA mortgage. Both loans feature a low-down payment option which lets you purchase without a 20% down payment, but some banks will require a larger down payment depending on your credit score.
FHA mortgage loans only require a 3.5% down payment if you have a credit score of at least 580. If your credit score is between 500 and 579, the down payment increases to 10% of the purchase price. Conventional loans require a minimum down payment of 5%, but your lender may require 10% if you’ve had a bankruptcy, foreclosure or short sale within the past seven years.
Higher Private Mortgage Insurance Premiums
Private mortgage insurance (PMI) is a type of mortgage insurance with conventional loans. You’re required to pay this insurance if you purchase a home with less than a 20% down payment.
Some borrowers don’t understand how credit scores affect private mortgage insurance premiums. With an FHA home loan, mortgage insurance is 0.85% of the loan balance regardless of a borrower’s credit score. PMI premiums with a conventional loan vary and range between 0.5% and 1% of the loan balance. Conventional lenders take into account different factors when determining the cost of PMI, such as the mortgage balance, the size of your down payment and your credit score.
PMI protects lenders in case a borrower defaults on his mortgage. Since borrowers with low credit scores have a higher default risk, they typically pay higher mortgage insurance premiums than borrowers with excellent credit.
