So it’s time to buy a home! Typically, you need a credit score of at least 620 to secure a loan from a qualified lender. This score illustrates you’re dependable enough to pay back any borrowed money on time. It is possible to still get a loan if you have a lower credit score, even one in the 500s. Continue reading to learn about all your options, and more!
Qualifying for a home loan
When you are qualifying for a mortgage, there are a few questions most lenders will ask. Things like, is your credit score good? Have you ever filed for bankruptcy, or can you explain any late payments or collections? And are your credit cards maxed out? Prepare ahead of time by first answering them yourself to determine your eligibility for a home loan.
Conventional mortgage loans
A conventional mortgage loan isn’t backed or guaranteed by the federal government. They can be a bit tougher to qualify for (a score above 740 will get you the best rate), but they fit a wider range of buyers and properties. Conventional mortgages are divided into two types of loans: conforming and nonconforming. Conforming loan guidelines are set by Fannie Mae and Freddie Mac, two government-sponsored enterprises that financially fuel the mortgage loan industry. Nonconforming loans are those made to borrowers who have poor credit scores, high amounts of debt, or recent bankruptcy. Because they’re a bit riskier, these typically have higher rates and insurance requirements.
Federal Housing Administration (FHA) loans
A Federal Housing Administration (FHA) loan is a mortgage insured by the Federal Housing Administration. They allow for down payments as low as 3.5% with a 580 credit score, so they’re helpful for buyers with lower credit scores and limited savings. They also have more flexible rules regarding gifts of down payments from family members, employers or charitable organizations, and in some cases, might have lower monthly mortgage insurance payments. You can obtain one of these loans at a bank, credit union or nonbank that is approved by the FHA.
Department of Veterans Affairs (VA) home loans
A VA loan is a mortgage issued by a private lender and guaranteed by the U.S. Department of Veterans Affairs. You must be a U.S. veteran, active-duty military personnel, or a surviving spouse to qualify for this type of loan. The program was created after World War II by the GI Bill of Rights to help veterans re-establish themselves after the war. Because of the VA’s guarantee, the government will repay the lender part of the VA Loan if the borrower cannot make payments. This makes borrowers less risky to lenders, and allows them to offer better terms and require no down payment. They also have limited closing costs (the various fees and expenses you pay to obtain a mortgage) to no more than 1% of the loan amount.
United States Department of Agriculture (USDA) loans
A USDA (United States Department of Agriculture) loan is available for rural homebuyers and is issued by the USDA Rural Development Guaranteed Housing Loan Program. There is zero down payment for the mortgage and they are divided into three loan programs:
- Loan Guarantees: The USDA will guarantee a mortgage issued by a qualified local lender and allows you to get lower mortgage interest rates, even with no down payment.
- Direct Loans: These are for very low income applicants. Income thresholds depend on the region and can have interest rates as little as 1%.
- Home Improvement Loans and Grants: These are loans or financial awards that allow homeowners to repair or upgrade their homes.
What to consider before applying for a home loan
So you’ve come this far in the article. Perhaps house-hunting is your next step. But, before you begin, we’ve got a few more tips for you. Start by understanding exactly how much you can afford to borrow from a lender. This will save you time and energy from potentially applying for loans you’ll just be turned down for. Keep reading to learn a couple more helpful hints.
Reduce your debt-to-income ratio
Debt-to-income ratio is the amount of your income going towards paying off your debt each month. If your ratio is more than 50%, that means you’re spending at least half of the money you make on your debt–which is too much! Here are some ways you can decrease your ratio:
- Pay off your loans ahead of time. Use either the debt avalanche strategy or debt snowball method, both tried-and-true ways of tackling debt to pay it back faster and efficiently.
- Negotiate a higher salary. We’re sure you deserve a promotion. Change your DTI by increasing your income and having more cash to pay off your debt.
- Get a side hustle. Another way to increase your income is by picking up extra work. It may make life a little more hectic, but it will help you eliminate debt faster.
Don’t open new lines of credit (hard inquiries)
When you open a new line of credit, this shows up on your credit report as a hard inquiry and can have a negative impact on your score. Essentially, you’re giving a lender or issuer permission to assess how likely you are to be able to pay back any money you borrow. If you need to check your credit score, do what is called a soft inquiry or soft pull. This won’t pull your credit report and is normally a free service provided by your credit card company. Avoid applying for several new credit cards within a short period of time as well. A good rule of thumb is this: only apply for one credit card every six months.
Prepare to provide proof of income and assets
The process of buying a home also includes showing proof of income and any assets you may have. Employed applicants can provide their W-2 form, while self-employed borrowers can use their 1040 tax returns. Mortgage lenders might also want to see recent pay stubs and/or a letter from your employer, especially if you’ve recently changed jobs.
You can provide proof of your assets by submitting an asset statement, or documentation of your net worth. There are different kinds of assets you’ll want to show: liquid, non-liquid, and gifts. Liquid assets are items you own that have a cash value, or are easily converted into cash. Non-liquid assets are things with value that don’t easily convert to cash, such as cars, jewelry, artwork, or self-owned businesses. And gift funds are any money you’ve received from a loved one that can be used towards a down payment or closing cost.
Talk to a financial coach to get a personalized action plan
If you’re feeling overwhelmed in this process, you’re not alone! Many people find buying a home complicated and confusing, whether it’s their first time or not. Seek out professional services at your bank or private financial consulting firm. They’ll help you come up with a plan specific to your needs, and take some of the pressure off!