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Watch Your Credit Score

If you are worried about what a lender will think of your mortgage application, spruce up your credit now, before you apply. This is their first impression of you. They look at your score before they evaluate anything else. They do this because the credit score tells them a lot about you. A great credit score means you are financially responsible and worth taking the time to evaluate. A bad credit score means you aren’t financially responsible and may not be worth the risk.

If you know you have low income, it’s time to work on that credit. Bring all of your accounts current and minimize the amount of outstanding credit card debt. Avoid applying for any new credit during the first few months leading up to your mortgage application, and don’t close any revolving credit accounts during that time either.

These habits will help your credit score improve, hopefully in time for you to apply for the mortgage you need.

Watch Your Debt Ratio

This is a big one if you have low income. The lender will pay close attention to your debt ratio because they need to make sure you can afford the loan payments. The lender will focus on your housing ratio (the amount of your gross monthly income that the housing payment would take). They will also focus on your total debt ratio too, though. The total debt ratio is the combination of all of your monthly debts including the new mortgage payment compared to your gross monthly income.

It’s safe to say that the lower your debt ratio, the greater your likelihood of getting the bigger mortgage. Of course, you can only secure a mortgage that fits within the housing ratio a lender allows. But different programs have different debt ratio requirements. If your DTI is high, you may want to consider the FHA loan. They have the most forgiving debt ratios.

FHA loans allow a front-end ratio of 31% and a back-end ratio of 43%. This is as about as forgiving as it gets, unless you are a veteran and are eligible for VA financing. Because the FHA has the most flexible guidelines, many borrowers turn to this program, and not just first-time homebuyers.

Apply for a Guaranteed Loan

The US government has several mortgage programs that are ‘guaranteed.’ The FHA loan is one, as is the VA loan and the USDA loan.

The FHA loan, as we discussed above, has the most flexible guidelines. It also has the guarantee of the FHA. They will pay the lender back a portion of the funds the lender loses should you default on your loan. This allows lenders to accept riskier qualifying factors, including a higher debt ratio from an applicant with low income.

The VA loan is for veterans that served enough time in the military. If you are eligible for the program, the VA gives the lender their guarantee should you default. The VA guarantees 25% of the loan amount the lender is stuck with if you default on your loan. This is how VA lenders are able to provide you with 100% financing and flexible qualifying guidelines.

The USDA loan is for borrowers that live in a rural area and whose total household income doesn’t exceed 115% of the median income for the area. The USDA guarantees these loans for lenders as well, giving lenders a little flexibility when providing you with a loan even if you have low income.

Your best bet when applying for a mortgage if you have low income is to make sure you have good qualifying factors first. Then you can start shopping for a loan, outside of the conventional guidelines. Conventional loans have the strictest requirements and are harder for borrowers with low income. Instead, sticking to government-backed loans can provide you with the greatest results.

You hear you need a good credit score to buy a house. Just what is considered good credit? How will you know if you qualify? Before you apply with a lender, read our guide on how to learn about your credit. The more information you have going into the process, the better your chances of approval.

Know the Minimum Credit Score for Your Program

Each loan program has a minimum credit score required. Starting there can help you determine where you stand. Following are the minimum credit scores for most programs:

Conventional – Fannie Mae won’t accept a credit score lower than 620, but most lenders require scores slightly higher
FHA – The FHA allows credit scores as low as 580, but will allow scores as low as 500 with a 10% down payment
VA – The VA requires a credit score of at least 620
USDA – The USDA requires a credit score of at least 640

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Keep in mind, these minimum credit scores are what each program requires. They are not what the lender requires. At a minimum, the lender must use the published guidelines. However, they can require higher credit scores if they wish. The lender funds the loan, so they have the final say in what type of risk they want to take.

Is a Good Credit Score Necessary?

Assuming you meet the requirements of the program and the lender, you may still want a good credit score. If nothing else, it helps you with negotiating your costs and interest rate. In general, lenders look at lower credit scores as riskier.

A lender must protect themselves against the risk of foreclosure. They do this by charging higher interest rates and/or closing costs. Because the lender is in the business to make money, they make sure they make the money up front. This way if you do default, they still made a little profit on your loan.

If you have a higher credit score, you may be able to negotiate a lower interest rate and/or closing costs. A higher score signifies more financial responsibility. Just how much you’ll save depends on the lender. There isn’t an exact calculation you can use. But, it does give you more bargaining power, especially if you shop around with different lenders.

If you borrow more than 80% of the home’s price, you’ll want a high credit score as well. This helps lower the amount of PMI you must pay. PMI stands for Private Mortgage Insurance. Every conventional loan with an LTV higher than 80% requires it. The insurance company bases your premium on your credit score and LTV. If you have a higher score, you may pay less PMI.

What if You Have a Low Credit Score?

Luckily, if you have a low credit score you may still secure a loan. But, it might be more expensive. The lender might bump up your interest rate. They may also charge you an origination fee. This is a percentage of your loan amount. So on a $100,000 loan, 1 point would be $1,000. Lenders can charge up to 3 points on your loan. That can really add up!

The good news is you can improve your low credit score. Unless you need a mortgage right now, take the time to implement some of our credit improving tips below.

Improving your Credit Score

Luckily, improving your credit score can happen fairly quickly. You must be consistent with your efforts though. First, you must determine why you have a low score. A few reasons may include:

High utilization rate – If your outstanding balance is more than 30% of your available balance, it can negatively affect your credit score.
Late payments – If your credit history is laden with late payments, you must bring your accounts current.
Accounts too new – If you don’t have established credit, it could affect your credit score. The older your accounts the better it is on your score

Here are a few ways you can make your score higher:

Pay down large balances. Start with the highest balance and work your way down. Credit bureaus figure your utilization rate based on your total available credit. They total all of your credit card available balances. They also total your outstanding balance. The ratio between the two is your utilization rate. Paying down large balances can help lower it.
Make your payments on time. You’ll need to establish a proper history of making payments on time. This doesn’t mean just a month or two. You’ll need to keep up the habit for the next 6 to 12 months to see a difference.
Don’t close old accounts – Even if you have accounts you no longer use, keep them open. If nothing else, the age of the account can help improve your credit score.

In general, watch how many new accounts you open as well. Each inquiry knocks a few points off your credit score. If you have too many it can negatively affect your score.

Before you apply for a mortgage, make sure you know what your credit looks like. Request your free credit reports from each credit bureau. This won’t show your credit score, but you’ll be able to see the history. You can fix any issues, such as those discussed above. Without any issues reporting, you have a better chance of having a higher credit score.

Many services offer free access to your credit score as well. Check with your bank or credit card companies to see if they offer it. This is a great way to stay on top of your credit without paying for credit monitoring. The services alert you when your score changes. This can help you make any necessary adjustments to make sure you have a good credit score for your mortgage.

The bottom line is you need a good credit score to get a loan. You might get away with a lower score, but it will cost you in the end. If you would rather save money, do what you can to improve your score. This way you never have to pay the higher rates or closing costs. These are investments you never make back. Invest wisely and you can make the most of your homeownership.

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How to Get a Bigger Mortgage Even If Your Income Is Low