Do you assume that you need great credit to buy a home? While it certainly makes things easier when you want to buy a home, it’s not necessary, even for first-time homebuyers. If you have less than perfect credit, you may have more options than you thought possible for your first mortgage.
FHA Loans are a Great Choice
Many first-time homebuyers turn to FHA loans. In fact, this program used to be known as the first-time homebuyer’s loan! Today it’s a loan for anyone that qualifies, but it’s a great place for first-time homebuyers to start.
The FHA program allows some of the lowest credit scores in the industry. Technically, you need at least a 580 credit score in order to qualify. However, you can have a credit score as low as 500 and still qualify, you just need to make a 10% down payment rather than a 3.5% down payment.
FHA loans have fairly flexible underwriting guidelines as well. They allow a 31% housing ratio, which means 31% of your gross monthly income can cover the total mortgage payment. This includes the principal, interest, real estate taxes, homeowner’s insurance, and mortgage insurance. They also allow a 41% total debt ratio. This means that 41% of your gross monthly income can cover the new mortgage payment plus any existing debt you have, such as credit cards, installment loans, or car payments.
You do need stable income and employment to qualify for the FHA loan and you can’t have any defaulted federal loans in your past. If you have a federal loan that you did default on, you’ll need a payment arrangement in place and proof that you make your payments on time to make good on the debt.
VA Loans Can Help Veterans
If you are a veteran of the military, the VA loan can help too. You’ll need approximately a 620 credit score in order to qualify, which in the eyes of most lenders is ‘fair’ credit. The VA loan doesn’t require you to make a down payment and it has flexible underwriting guidelines as well.
In order to get the VA loan, you need to prove that you are eligible for the program. Just being a veteran isn’t enough. You must have served enough time and have an honorable discharge. If you served in the regular military, you must serve 90 days during wartime and 181 days during peacetime. If you served in the National Guard or Reserves, you must serve at least 6 years.
The VA doesn’t put a lot of emphasis on a borrower’s debt ratios. Instead, they focus on your disposable income. They have a specific amount of money they want each borrower to have left over in order to cover the cost of living. The amount that you need depends on your family size and the area that you live in. Overall, though, the VA would like it if your total debt ratio doesn’t exceed 41% of your gross monthly income. In some cases, they can stretch it to 43%, but you will need to have 20% more disposable income than required for your family size/area in order to qualify.
If you can’t qualify for an FHA or VA loan, you may want to look at subprime loan options. Many people avoid subprime loans because of the blame placed on them for the housing crisis. Today subprime loans are more secure and a good option for people with less than perfect credit.
Subprime loans mean that the lender keeps the loan on their own books. They don’t sell it on the secondary market. This allows the lender to create their own requirements for the loans. They may have more flexible guidelines or be able to give you an option for a loan even if you have a low credit score.
Just like any other loan program, subprime lenders typically want to see compensating factors. In other words, they want something to counteract the low credit score as that creates a high risk of default. The typical compensating factors are money saved in an emergency fund, a low debt ratio, stable income, long-standing employment, and a large down payment. If you can swing one or more of these factors, you can put yourself in a good position to get a subprime loan despite your low credit score.
First-time homebuyers don’t need perfect credit. There are many options out there to help you get the loan you need without a great credit score. The key is to shop around and see what various lenders have to offer. You may find the loan that will suit you the best in the least likely place.