The latest numbers from mortgage analysts Ellie Mae show that the average FICO score of approved conventional mortgages is 732. If a borrower has lower credit scores (650 and under), then that average FICO score could seem like a chasm between them and the home they want to buy. However, just because the average credit scores for a conventional mortgage are above 732 doesn't mean low-credit borrowers are shut out of homes.
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1. USDA Loans
USDA loans are a great option for borrowers with low credit scores, because the minimum score for approval is 640. Not only that, but you won't have to make a down payment for this mortgage. It sounds like an incredible deal and, for the consumer with bad credit, it is a legitimate option.
2. State Bond Programs
While the USDA program is available in all states, bond programs tend to be specific to certain states. For example, Florida's first-time homebuyer bond program offers up to $15,000 toward down payment and closing costs. The product is treated as a second mortgage.
3. FHA Loans
Ellie Mae estimates that 689 was the average credit score for borrowers who were accepted for an FHA loan. These loans require a 3.5 percent down payment if the borrower's credit is 580 or higher, Zillow says, while scores between 500 and 579 require a down payment of 10 percent. The standard for the total mortgage payment is 31 percent of income, and DTI needs to be less than 43 percent. Mortgage insurance applies to the life of the loan.
The FHA has their own criteria for the condition of the home the borrower is buying—if certain things need to be fixed, those fixes have to happen before closing and paid for out-of-pocket by the seller. However, if the borrower can find a home in good condition with only minor repairs noted during inspection, closing should proceed with the normal aches and pains.
Some Final Thoughts About Mortgages for Bad Credit Scores:
It's important to remember that borrowers have bad credit scores for a variety of reasons. One of those reasons could be that the borrower has high credit card balances around 60-70% of their credit limits.
While most of us see this as a credit score issue - high utilization leads to lower scores. The more important area of concern is debt-to-income ratio. Having multiple cards with large balances leads to high payments, cutting in to a borrower's debt-to-income ratio and pushing them past 45 percent, High debt-to-income ratio isn't a hard and fast mortgage death sentence, it is the number one reason why borrowers are rejected for a mortgage.