The Short Answer
According to Fannie Mae and Freddie Mac, you can get a mortgage with a credit score as low as 620. “Officially,” you can get an FHA loan with a score as low as 500 (with 10 percent down). The VA has no minimum score requirement.
The Complete Answer
However, to be approved with low FICO scores (unless you can show that you’re an identity theft victim or otherwise innocent), your recent credit history would have to be excellent, your income would have to be very stable and more than sufficient (low debt-to-income ratio), and your down payment would need to be big (most likely at least 20 percent for a non-government loan and ten percent for a government-backed mortgage). You cannot get a mortgage with the lowest acceptable scores if the rest of your application is marginal.
So, what’s the “real” credit score needed for a mortgage?
According to mortgage data analysts at Ellie Mae, the average FICO score for approved applications was 730, and the average score for denied applications was 669. However, that’s not the whole story. Declined loans also had higher debt-to-income ratios (46 percent versus 37 percent for approved loans), which significantly contributed to the underwriting decision. In addition, average credit scores for approved FHA loans were considerably lower, at 683.
Mortgage decisions are often made by automated underwriting systems (AUS) and then double-checked by human underwriters. Lenders know what statistically affects your likelihood of repaying your loan, and have created systems designed to quickly evaluate all of those factors and make a fast decision.
Factors that increase the credit score needed
You’ll likely need a higher credit score to offset these things if they are present in your loan application:
- Payment shock. If your new house payment will be significantly higher than your old one, that’s called payment shock. For example, if your current rent is $1,000 a month, but your new principal, interest, taxes and insurance would run $2,500, that’s a 250 percent payment shock — which increases your odds of mortgage default.
- Small down payment. The lower your out-of-pocket expense to purchase your home, the more likely you are to walk away if you have trouble making your payment, and the more likely the lender / mortgage insurer is to take a loss in a foreclosure sale.
- Spotty job history. If your job history reveals a lot of jumping around with little or no increase in pay or responsibility, that’s a red flag for lenders. If you’ve had your current job for less than two years and have not established a track record in your field, or if you work in an industry that’s experiencing economic problems, your credit becomes even more important.
- High debt-to-income (DTI) ratio. Your DTI equals the total of your proposed housing payment (principal, interest, taxes, insurance, HOA dues, etc.), plus your monthly account payments (credit cards, car payments, student loans — but not living expenses like utilities), divided by your gross (before tax) income. So if your proposed housing expense is $1,000 per month, your other bills add up to $500 a month, and your income is $3,500 a month, your DTI is $1,500 / $3,500, which is 43 percent. That’s on the high side, so you probably need a higher FICO to get approved.
Factors that decrease the score needed
The flip side is that certain other factors can lower the score needed to get a loan approved.
- Conservative use of credit. If you keep your balances low and make your payments on time every month, your good credit can overcome a bad score.
- Reserves. “Reserves” are funds that will be available to you for paying your mortgage after you close on your home loan. Reserves are measured in months. For example, if your new housing payment will be $1,000 a month, and you’ll have $6,000 in savings after closing on your home purchase, you’ll have six months of reserves. Having more than two months is considered a factor in your favor.
- Habit of saving. If you can show that you save money every month, it demonstrates to lenders that you have some discipline with your money.
- Big down payment. This is probably the most important factor because the more “skin in the game” borrowers have, the less likely they are to default. In addition, even if they do default, borrowers who make larger down payments are less likely to be upside down — the lender has a good chance at recouping its money in a foreclosure sale.
- Low DTI. Higher income and lower expenses make it easier for you to repay your loan as agreed. If your income is stable or increasing, and your expenses are not too high, you can overcome a marginal credit score.
Your score is NOT the same as your credit
Lender guidelines allow for approvals with bad credit scores, but not necessarily bad credit. Your score can be low for many reasons unrelated to your payment habits. For example, it takes years to achieve a high score, and those with short credit histories don’t have high scores, even if they manage their debts well. Other reasons for low scores include high number of accounts, too many new accounts, and high balances. These and other reasons for low scores may be acceptable to lenders. However, that’s not the same as allowing loans to people with actual bad credit. FHA says,
Past credit performance is the most useful guide to determining a borrower’s attitude toward credit obligations, and predicting a borrower’s future actions. Borrowers who have made payments on previous and current obligations in a timely manner represent a reduced risk. Conversely, if a borrower’s credit history, despite adequate income to support obligations, reflects continuous slow payments, judgments, and delinquent accounts, significant compensating factors will be necessary to approve the loan.
Final thought: All lenders evaluate differently
You probably know what to expect if your FICO is 800, you’re putting 20 percent down and your DTI is 25 percent. Easy peasy. And you also know where you stand if your credit report looks like Whitey Bulger’s rap sheet, you have three percent down and started a new job last week. It’s those on the “bubble” who are unsure of their likelihood of mortgage approval.
If you “just miss” with one lender, get the reason(s) for declining your application (they have to provide this by law), and contact other lenders. Ask them if their guidelines would allow them to approve you. Applying and going through the AUS process takes almost no time and costs little or nothing. Contacting more lenders or going through a broker who can do that for you may increase your chance of getting good news.