You’re probably already aware that your credit score plays an important role in your ability to apply for a mortgage. But what you may not realize is that it even limits the types of loans and loan programs that you are eligible to apply for.
Here are the minimum credit score requirements for the three primary mortgage types—VA, FHA, and conventional. Your credit score may determine which of these loan programs you can participate in.
Resource: You can get your score online for free at Experian.
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VA Mortgages—No Credit Score Required (Sometimes)
The VA is alone among mortgage programs in that it doesn’t always have a minimum credit score requirement. However, that’s something of a technical dodge on the issue. The VA will not accept poor credit, which is usually indicated by a low credit score.
VA guidelines require that mortgage and/or rent history be carefully evaluated. This is seen as the best indicator of a borrower’s willingness to honor a new mortgage. If you have a poor history of making your monthly house payment, you will likely be declined.
Although the VA may not specifically require a certain minimum credit score, individual lenders who handle VA loans are free to impose their own credit score minimums. And, in fact, most do.
It’s not unusual for a lender to impose a minimum credit score requirement of at least 620. The required minimum may even be considerably higher if the loan amount you are applying for is above the $417,000 threshold (historically considered the dividing line between conforming loans and “jumbo” loans).
VA underwriters are also required to consider recent bankruptcy and foreclosure situations. A sufficient amount of time must have passed since the bankruptcy or foreclosure took place. To get a mortgage shortly after a bankruptcy or foreclosure, you must have a clear indication of extenuating circumstances, such as the loss of a job or business, or a serious medical condition. In most cases, at least 12 months will have to pass before you will be eligible.
VA loan pros
With or without a credit score requirement, VA loans have several significant advantages, including:
- A zero down payment requirement.
- No monthly private mortgage insurance. However, there is an up front funding fee that can be included in the amount of the new mortgage (technically giving you a mortgage that is greater than 100% of the value of the property that you are purchasing or refinancing).
- VA income and credit guidelines are more relaxed than those for FHA, and especially conventional mortgages.
VA loan cons
Despite the advantages that VA mortgages provide, the potential is real that such a loan could put you into a housing situation that you cannot truly afford. For starters, 100% financing means you’ll have zero equity in the property. And zero equity translates into zero cushion in the event you need to sell or refinance the property. Also, the relaxed income and credit guidelines could enable you to purchase a home before you actually have the discipline and financial strength to do so successfully.
FHA Mortgages—Minimum Credit Score Required: 500 to 580
FHA mortgages, unlike VA loans, actually do have stated minimum credit scores. However, the minimum scores required are considerably lower than with conventional financing.
FHA actually has two minimum credit score tiers. With a minimum score of 580, you can qualify for a 3.5% down payment loan; with a minimum score of 500, you can qualify for a 10% down payment loan.
However, it should be noted that despite the stated low credit score minimum requirements, few mortgage lenders are willing to approve loans with scores below 620.
Why would a lender refuse to underwrite a loan with a borrower’s credit score of 580 when FHA would actually allow it to be the case? Here’s something few home buyers are aware of: neither FHA—nor the VA for that matter—is a direct mortgage lender. Instead, each is actually a government-sponsored mortgage insurance agency.
Both FHA and the VA establish minimum guidelines for mortgage lenders to use, but lenders are always free to impose stricter requirements. Since the financial meltdown a few years ago, mortgage lenders have become keenly aware of potential mortgage defaults. No lender wants to make too many loans that end up going sour. There can be long-term consequences with either the FHA or the VA for a lender that has an excessive default rate.
Still, a lender might be convinced to accept a credit score as low as 580 if there are “compensating factors.” These can include:
- A low debt-to-income ratio (housing + debt payments, divided by stable monthly gross income)
- A very small increase (or decrease) in the new house payment
- Additional income that is documented to exist, but is not used to qualify
- Cash reserves after closing (reserves are expressed as the number of months a borrower has in liquid reserves relative to the new monthly house payment)
One more point on the credit score requirements of FHA: FHA loans can be made to a person with no credit score at all. This is limited to borrowers who do not use credit, and therefore would not have credit scores. However, FHA does require verification of regular monthly payments made for rent, utilities, insurance, and even private loans that will not report to credit reporting agencies.
FHA loan pros
Much like the VA, the FHA takes a more relaxed view of a borrower’s income and credit situations. They also permit the use of various down payment assistance programs that can effectively create a zero down payment situation for the borrower.
FHA loan cons
FHA loans have the potential to enable you to buy a house you can’t comfortably afford. Since FHA often defaults in favor of the borrower, it’s possible that the borrower may be approved for a mortgage before he or she is truly ready. For example, the fact that FHA does not require the borrower to have cash reserves after closing puts the borrower in a position of being broke as a new homeowner. Also, FHA charges both monthly and up front mortgage insurance premiums (MIP), and the monthly payment continues for the life of the loan.
Conventional Mortgages—Minimum Credit Score Required: 620
As the chief provider of conventional mortgage financing, FNMA and FHLMC have a stated minimum credit score of 620. However, you may have a difficult time qualifying for a conventional mortgage with a credit score anywhere in the low 600s.
Much as is the case with FHA and VA mortgages, lenders often impose higher requirements than those issued by Fannie Mae and Freddie Mac. And there’s good reason for that too: FNMA and FHLMC can require that a lender repurchase a loan that goes into default under certain circumstances. That policy makes lenders understandably gun shy.
If your credit score is even close to 620—say below 640—the lender may decline your loan unless you can provide adequate compensating factors (once again, a low debt-to-income ratio, high cash reserves after closing, or a small increase in the new house payment).
A lower credit score may also result in a higher interest rate, particularly on minimum down payment loans. Now that FNMA and FHLMC have brought back 3% down mortgages, credit scores have become even more important.
Private mortgage insurance (PMI) is another factor your credit score impacts. For example, on a 5% down loan, MGIC will charge an annual PMI premium of 0.41% of the mortgage amount if your credit score is 760 or higher, but 1.61% if your score is only 620.
On a $200,000 mortgage, this will result in an annual PMI premium of $820 if your score is 760 or higher, or $3,220 if your score of 620. That’s four times more money out of your pocket each year.
Conventional loan pros
Unlike FHA loans, conventional loans don’t require upfront mortgage insurance—just monthly payments rolled into your overall mortgage payment. And unlike FHA loans, PMI can be cancelled on conventional loans when the mortgage balance is paid down to 80% or less of the property value, either through amortization, or through an increase in the property value. In addition, a 3% down mortgage requires less money upfront than the FHA 3.5% down payment requirement.
Conventional loan cons
In general, conventional loans are stricter in regards to income, debt-to-income ratios, and cash reserves than VA or FHA loans. Those requirements are even more strictly enforced on loans with low credit scores, and particularly those with both low credit scores and low down payments. And of course, low credit scores will result in a higher interest rate and annual mortgage insurance premium.
Your credit score can have an impact on which mortgage type you can apply for. If you have a credit score below 580, then you should consider a VA loan if you are a qualified veteran, or an FHA loan with a 10% down payment if you’re not. And if you’re at or above 620, you can try your hand at a conventional loan.