500-640 Credit Score? Here's How To Get A Mortgage Approval

Certified Mortgage Advisor
NMLS 1701021
Published 
May 5, 2021

Three-part plan for low credit score

So we have a three-part plan to help you get alone with a low or a bad credit score. Number one is to pick your timeline. Number two is to understand the core problems. Then number three is to start taking action.

I've personally funded loans for people all the way down to a minimum of a 515 credit score. One of the kindest people I've ever worked with as a buyer was a disabled veteran who was about the same age as me. He had a 515 credit score because of some past medical debt and some other things that he wasn't able to keep up with. Again, because of his disability, we were able to get him into a VA loan, 0% down, zero monthly mortgage insurance, a fantastic interest rate all with a 514 credit score.

1. Pick your timeline

So number one, we need to pick the timeline. There are two main timelines that we will discuss.

Buy now with low credit

The first one, this option is a bit faster. This is the fastest option. And this is to buy a home right now with low credit. We'll talk about again, what that means and some strategies here, but you buy now, then you build credit while you're in your home, and then you can refinance into a cheaper loan because often when you buy here in the beginning you will run into an issue where the interest rate might be higher, or the terms might not be favorable.

Build credit first, then buy

Then number two is to look at building credit first and then buying in this process is slower. So you want to pick those two timelines of what works for you and we'll explore through this video, start to understand which one might be best for you moving.

2. Understand the core problems

After you pick your timeline, then is when you want to understand the core problem. Because we can talk about and say, "okay, I have bad credit". What exactly about the credit is bad? Because there's something specific about the credit history that's holding you back from purchasing a loan. It's not that you just have this vague idea of bad credit. It's not just, there's good credit and there's bad credit. There is credit amongst all these ranges and they each have different stories and components that we need to figure out.

Follow the rules

So sometimes I hear people talk about this idea of the system is just rigged to get me, and it's really not because mortgages have rules, just like if we played a game of monopoly, it has rules to win the game. You have to follow the rules. These are the rules that you need to follow to get a loan. It's not about who you are as a person. It's just simply. Your current situation, your current credit might be outside of the rules. And so of course, you're not going to be able to play the game. If you're not playing by the rules, I'm going to teach you what the rules are so you can figure out how you can actually play the game.

Understanding the core

Understand the core issue or issues that are going on with your credit. That's going to help you create a plan. Moving forward. That way you can talk with a credit coach, or you can figure out your timeline, or you can talk with a lender and say, I know this is what's holding me back, but until we know exactly what's holding us back, we're going to feel like everything's stacked up against us. We need to know specifically where the problem is.

Minimum score for each loan type

So first of all, let's talk about the minimums. This is the first problem you're going to run into. There are minimum credit scores with each main loan type. So here are the four main types of loans, conventional FHA, VA, and USDA.

For Conventional

So conventional minimum credit is 620 conventional loans are super difficult to do. If we have rough credit, even if we have a 620 plus let's say we have 620, but we have some missed payments here. It might be difficult to qualify for conventional.

FHA

FHA is then the most common that you'll see in the low credit score or bad credit space. And so there are two different minimums and this changes the down payment.

So FHA, it goes all the way down to a minimum of 500 credit score. Now, not all lenders do that, but that is the base minimum score so we can work to find a lender that uses 500 scores. So if we do 500, the down payment is 10%. If we have a 580 plus, then the down payment is 3.5%. So you can see the down payment changes based on the credit score.

So right here, you might be thinking I can only afford 3.5% down. And so my credit score is maybe 560. So there's our first issue. We need to work on getting the credit score up so we can afford this.

VA

Down-payment VA and USDA or two other options. VA goes down to 500 and USDA goes down to 500 as well. These are a little bit more niche because VA is only for veterans. USDA is only for rural areas and there's an income limit as well. So they're more restrictive. That's why FHA is going to be the most common. And we'll talk mainly about FHA here. So VA goes down to 500, although most lenders. Won't do VA unless a 620, it's an overlay that they have. It's just a role that they want, but there are still lenders that do down to a 500. Again, I funded a 514 as the lowest credit score loan that I've done on a VA loan.

USDA

USDA goes down to 500. However, this has to be manually underwritten whereas a 640 allows you to do automated underwriting.

Remember that is not just about the credit score

So your credit score is half of the story. Sometimes I think that's where we get tripped up is sometimes I talk to people who have at 640 or 680 and they still have issues getting qualified because again, a credit score is only part of the story. It's only one number the credit score the other half is why is the credit score there in the first place?

What can affect your credit score?

Were there events that caused the credit score to get there? Or that causes there to be more to the story than just the score itself. And so these can be things like. I'm a bankruptcy, a foreclosure, a short sale, a deed in lieu of foreclosure, any collections accounts that you have, missed payments, medical bills. These are things that in tandem work with the credit score.

Credit score = your payment history & events

So the credit score is going to just show a number, an overall number about what's happening. But it doesn't tell the details of the story. Mortgages are interested in the details of the story along with the number. So we might have, above those minimums, we might have a 520 credit score. We can qualify for an FHA loan if we have 10% down, but we might've had a bankruptcy that was super recent and that keeps us from qualifying. So that's something we have to watch out for.

How long does an event stays in your credit report?

So here are the waiting periods for some of these events. So deed in lieu of foreclosure, it's a three-year waiting. If you have a foreclosure it's three years as well, even if the foreclosure was included in the bankruptcy, you have to use the date of the foreclosure and not the date of the bankruptcy discharge for a short sale. It's three years for a Chapter 7 bankruptcy. It's two years from discharge for Chapter 13.

This one's a little bit tricky. Basically, the rule is 12 months of on-time payments and court approval. And that qualifies you for a manually underwritten loan. For an Automated Approval, which is AUS. You have to have a minimum of two years of waiting periods, to be able to get an FHA loan.

Mortgage Lates

Again, if you're doing an automated approval, you can have up to 3x30 days late, 1x60 days late, and 1x90 days late. However, automated approval doesn't often give approval on those numbers. Manual requires 12 months of no mortgage late. So that brings us to two types of underwriting. If you're, if you have bad credit you're going to be exploring two different types.

Underwriting and how it works

Most people aren't familiar because they go through automated underwriting and basically automated underwriting or automated underwriting software. AUS is when a computer software says you're either approved or referred, which is basically the computer can't approve you. So computer software is going to take in information from your loan application and information that your loan officer put in there, and it's going to basically say thumbs up or thumbs down to the loan. Most lenders like to see the thumbs up because that's the easiest, it's easiest when the computer can evaluate the loan based on its risk profile.

However, when the computer can't, it gives a thumbs down to where it's going to say "refer". It's not going to say deny. It's going to say refer. And so when you have this refers, it's going to push you into manual.

Manual Underwriting

Manual underwriting is basically where instead of the computer software, giving a thumbs up or thumbs down an underwriter themselves has to come through tons of details about your credit and your personal situation to see if they're going to be willing to give you a loan or not.

So the criteria for the loan becomes a lot tighter, and you're often running into higher interest rates because these loans are riskier than if a computer approves it based on its risks profile. So you may be running into this if you're getting a loan with bad credit.

Compensating factor

With manually underwritten loans, since the computer can't approve it, they want to look for what's called compensating factors. So basically what things can offset the computer said, no, what can we share? That gives the underwriter a better feeling that we can pay back this loan, even though we didn't get approved by the computer.

12-months on-time payments

So a huge thing with manually underwritten loans is 12 months on-time rental payments. So here's another thing where we can spot issues. If you've been late on your rent, you're not going to be able to qualify for a loan. Unfortunately, we're going to need to extend that timeline until you have 12 months of on-time rental payments. That's huge for manually underwritten loans.

Reserves

Normally this is one to three months worth of reserves, which is if your future housing payment, your future mortgage, payment's going to be a thousand dollars a month with taxes, insurance, and everything, then you need to have one to $3,000 extra in your bank account. After you pay your down payment and closing costs. That's what reserves are.

Basically, the lender wants to see that you didn't empty out your bank account to be able to qualify for a loan. They want to make sure once you paid down payment closing costs, that you can still afford the monthly.

They're also going to put a limit on the late payments that you can have, and this is going to depend on the lender and the type of loan. But for instance, they might say we only allow one installment late in the past 12 months, or maybe they say zero lates on a revolving account. And so it's going to depend again on the lender, their overlays, and the type of loan.

Debt-to-income ratio limits

There's also limits on the debt to income ratio. Okay. So how much debt you're able to take on if you're going with automated approval, if you're able to get approved by the computer software, you can often take out a lot more mortgage than if you get a manually underwritten loan.

If you do manually underwritten, it's going to shrink how much you're able to take on as a mortgage payment.

FHA compensating Factors

So I have a chart here. These are FHA compensating factors that correlate with the credit score and the debt to income ratio. So it can be a little confusing for a second, but I want to run through a scenario here.

So let's say, for instance, you have a 580 credit score, and the loan officer runs your loan through the software and it comes back and it says, "refer". It says, "Hey, can't get approved". So we need to go manually underwritten. So let's first look over here and this left column 580.

So we can do any of these three. So now there are three ratios for the loan as well. How much debt can we take on on our loan? And so for some people. This might be perfectly fine, 31%, 43% debt-to-income ratio.

580 credit is for manually underwritten loan

But basically what this is saying is if you have a 580 credit score, we're doing a manually underwritten loan. And as long as our debt-to-income ratios fall within this range, 31% front end 43% backend, then we don't need any compensating factors. That means we don't need anything extra. We have on-time rental payments and everything else should be good as long as we don't have any extra late that the lender doesn't want to see.

Requirements if you want to stretch your DTI

However, if we need to stretch the debt-to-income a little bit higher, maybe we need to go to 47 instead of 43, we need one of the following: verified and documented cash reserves, minimal increase in housing payment, or residual income.

So we went up to 47%, so we need cash reserves, or maybe we need to go up to 50%, so we need to have the following. Maybe we need cash reserves and a minimal increase in housing payments. So your lender can help you specify what this is. But basically what we can see here is there's this correlation between if we need automated approval or mainly underwritten, then we can follow in the next step, manually underwritten loan. Where does our credit score need to be for how much debt-to-income ratio we need? Once we're in there, what kind of compensating factors do we need. So it's this kind of flow chart that goes down, that you can see with what is the issue that is stopping you from getting a loan? Because a lot of people aren't familiar with this, and again, it sounds like why do I need to know all this?

You need to know this?

You need to know why aren't you able to qualify for a loan. Is it because you're not meeting the minimum credit score limit. Is it because the software didn't approve you? Is it because your debt-to-income ratio is because of the compensating factors, there are things stopping you from getting the loan, even though that you might be able to get around if you understand the rule of the game.

That way you can come to a lender and say, "Hey, I know I have a 520 credit score. I only need this amount of debt-to-income ratio. And I have these compensating factors". That's going to help you get a loan, get that process through instead of a lender saying, "we don't do mean underwritten loans" and then pushing off somewhere else.

Know the things that you need

You need to come in with, to the table, knowing exactly what you need. That way you can get this pushed through easily because unfortunately. A lot of lenders just don't do mainly underwritten loans or they're not familiar with them. I started doing them because I was coming across a lot of people who I wasn't able to get qualified through underwriting saw. But at the same time, I didn't want them to knock it alone and I also needed a paycheck. So I was like, I'm going to figure out the rules of this so I can help people get into a loan the way that they want to and help them get through the rules, helping them understand it so they can qualify for a mortgage if they want to.

3. Start taking action

So you figured out what is your timeline? Maybe you wanted to build credit first. Then buy a house, that's perfectly fine. If that's what you want to do, or you want to buy a home first, then build credit. You're going to have to do your own research on what you want to do moving forward with your timeline.

So you did that, then you figured out what is the core problem? What's the main thing that's holding you back from qualifying for a loan. That way you can start taking action.

Don't let credit get in the way and then just sit back and mope

I see this happen so often. There are things that happened in the past, whether it was something that you did or something external that happened in your credits in place where you can't qualify instead of just sitting and feeling defeated and seeing like everything's against me, I'm just not going to do anything and complaining like that.

That's never going to get you to where you are. If you have a direction that you want ahead and you have to do the things to go in that direction, you can't just sit and be idle and expect things to change around you.

Expect work

You're going to be working on your credit. You're going to be working through this loan process. This loan is not going to be easy. There are countless people that have been able to get approved through mortgages with less than a 600 credit score, anywhere between 500 to 600. But they're not easy loans to do. They're going to require work. They're going to require paperwork. It's going to be frustrating and exhausting.

Just expect that to be par for the course, they're not easy to do, and you're gonna be working with lenders who may be slower because they take on loans like this. So just expect it. When problems come up, of course, there's a problem, don't take it personally. This is just part of the rules of the game. We have to follow the system to be able to get what we want.

Explore manual underwriting

I have the handbooks or the guidelines that lenders use for FHA, USDA, and VA so you can check those out again, read through them. See, what is the problem that's keeping you from qualifying for a loan. See if there are compensating factors you can use to help yourself qualify.

Work on a credit plan

Maybe you want to do a hybrid of those two timelines. Maybe you want to work on credit for the next two to three months and then buy a home. Maybe you want to buy a home. Now, maybe you wanna work on credit for a year before you buy a home. Either way, it's usually beneficial if you have bad credit to work on things, to improve your credit.

My Credit Guy

So look at something like a company like MyCreditGuy.com,  I don't get any affiliates or anything from them.

Your credit tells a story

Basically, what we're looking to do with credit is you're wanting to tell a better story. Your credit store score tells a story about how you handle debt and how you pay back debt. If you have bad credit unfortunately your credit score, your credit history has been telling a bad story about the way that you handle money.

Don't live in the past, move forward

Again, whether that was your fault or someone else's, it doesn't really matter. It's in the past. At this point, we're working on a plan. Moving forward. A bad story has been told. What we need to do is now tell a better story. There's no good story that's just bad the entire time. A good story includes some bad and a lot of good.

So if we're at the point where it's just some bad, let's start seeing what we can do to tell some more good stories. More good ways about how we paid back debt, how we are now making on-time payments, even though some were late, how we re-established good money patterns after a bankruptcy, those are the better stories that we need to be telling.

Track your credit score

Also, consider tracking your credit score that we can see is the work that you are doing. Then. Changing the moments when my credit score, is it continuing to go up? Is this thing stable? Is it going down or the things that I'm doing, the practices that I have with my money, actually helping me get closer to qualifying for a loan or qualify for a refinance that saves me more money in the future.

There are tons of free ones out there. myFICO.com is the most accurate that I've seen. However, you can use any of the free ones. myFICO.com is I think 40 bucks a month. So you absolutely don't have to do it. They're not an affiliate. I'm in no way connected with them, but they are the most accurate if you're interested in that.

Recommended Lenders (non-affiliate)

Here are some lenders that I would recommend. So I have no affiliation with any of these lenders. I can't vouch for them, and I have no relationship or connection, or affiliation. I just know that these lenders do have the potential to help you if you do have bad credit.

The main reason why is because most of them are brokers or they're services that allow lower credit scores were most don't. For instance, a lot of big companies we'll cap our we'll put a minimum of their credit scores, even at 620, some even higher.

So a company like NEXA Mortgage, they're a broker. So they have a wide range of options and to be able to. They can connect you with lenders that go down to a 500 credit score. Gustan Cho Associates, also a broker they have great educational resources online that they can shop around and help you find a lender down to 500.

Carrington mortgage services are often who I would use as a broker, and I would direct clients to them and basically broker loans through them. So there is usually no cost difference between if you're going direct through Carrington or broker often going broker actually saves you more money than going direct.

Don't take no for an answer, explore your options!

These are some options you can explore. I would start here and see if you can connect with somebody who can help you out. You don't have to take no for an answer. If somebody says, "Hey, you're not able to be qualified". Great! Let's move on to somebody else. Let's see somebody who can help us. At a minimum, we need somebody who can help us get on a game plan. We don't need somebody to just to say yes or no to us, we want to either be, "yes, here's the work we need to do or no, here's the work that we need to do to be able to get you into the home that you really want".

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