If you’re wondering, “Can I buy a house with a 580 credit score?” or “What is the minimum credit score needed to buy a house?”, then this article is for you.
For the majority of Americans buying a home is the single largest investment of their lives.
As such, you need to understand the factors that will determine how much you will pay, so you can make educated financial decisions.
In the following paragraphs you will learn how credit scores affect mortgage approvals, as well as additional factors both you and your lender may take into consideration.
But first, I have always felt that a working knowledge of the industry helps to put things in perspective so you can better adapt to the rules, so I will begin by explaining a bit of what happens behind the scenes in the mortgage industry.
What Credit Scores Do Mortgage Lenders Use?
The type of credit scores used for credit decisions in the mortgage industry are called FICO scores.
A FICO credit score is a numerical representation of the likelihood of a borrower falling behind 3 months or more on their mortgage payments.
The lower the credit scores, the higher the risk the lender won’t get their money.
Since banks are in the business of making a profit, then they need to ensure they see a predictable return on their loans. They accomplish this by charging a higher interest rate to those borrowers that are a higher risk.
That means the lower your credit score, the more you will pay in interest payments over the life of the loan.
Who Decides What Credit Score Is Needed?
A common misconception is the belief that the bank who underwrites the loan keeps the loan, so they decide what credit score is needed to buy a house. This is almost never the case.
Almost all loans are sold to investors in the secondary market.
The 2 largest investors are Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae).
Freddie is usually the buyer of choice for loans written by small lenders while Fannie handles most of the institutional lender’s business.
Government National Mortgage Association (GNMA or Ginnie Mae) insures loans which have been bundled into Mortgage Backed Securities (MBS) and sold to investors like hedge funds. FHA and VA loans are included in this program.
Since the investors on the secondary market are the ones buying the loans, they are the ones that determine the minimum requirements for what they’ll buy (or what they’ll insure in the case of GNMA).
Minimum Credit Score Requirements
Although Freddie, Freddie, and Ginnie all rely on FICO scores, they do differ on calculation and requirements.
Fannie won’t buy anything with less than a 620 FICO score. Borrowers must have at least 2 scores to qualify. The second highest score is used for credit decisions. They also require specific FICO score versions.
The following is a snapshot from the Fannie Mae’s seller’ guide.
Freddie also requires a minimum credit score of 620, but they have a variety ways of calculating scores including averaging out the scores.
The following is a snapshot of Freddie Mac’s guide for lenders.
Ginnie only packages and insures loans which are sold to investors. They don’t actually buy anything, but since they’re on the hook if the borrower defaults, then they get to provide the minimum requirements for what they will insure. GNMA typically requires a minimum credit score of 550.
Can I Buy A House With A 580 Credit Score?
Lenders are also free to add their own requirements to the minimums set by Fannie, Freddie, and Ginnie. These increased lender requirements are called “overlays”.
A lender uses overlays to reduce their risk. A lender may have to buy back the loan if the borrower defaults in the first year. Too many loan buybacks will drive a lender out of business.
Some banks are more risk averse than other banks. The result is that not every bank will underwrite the same loan or give the same terms.
For example, during the nationwide lockdown in 2020 unemployment reached record high numbers.
Major lenders such as Chase and Well Fargo increased their credit score requirement to 680 and 700 for all loans to try to reduce their exposure.
Some overlays are very common and accepted as the norm for most lenders. The most common overlays used for credit scores are:
- Conventional 640
- FHA 580
- VA 620
Overlays are the reason not all lenders will underwrite a FHA loan down to 580. Their overlays may not permit them to entertain the loan without some compensating factors.
How to Improve Your Chances For Approval
At times, some lenders may consider underwriting a loan that doesn’t meet their overlays if there are compensating factors present.
A compensating factor is an element of your application that would offset the lender’s risk of borrower default.
Here are some examples of compensating factors that could potentially help you buy a house with a low credit score:
- Credit scores – Low credit scores resulting from a divorce when the accounts in question were your ex-spouse’s responsibility.
- Rental history – Showing proof you have paid your rent on time for the past 12 months can strengthen a questionable application.
- Low debt to income ratio – if your proposed mortgage payment is only a fraction of your total income, then that helps your application.
- Low loan to value – the larger your down payment, the less risk the lenders perceives, since you have as much to lose as the bank if you should default.
- Total assets – if you have several years worth of mortgage payments available in your savings or investment accounts, then the bank is less concerned you won’t be able to pay.
Finding the Right Lender
Because each lender has their own overlays, there is no way for the average homebuyer to know which lender is the best fit for their loan scenario.
Mortgage brokers are popular because they leverage their knowledge of the programs offered by various lenders to improve your chances of approval. However, brokers are not banks. This means they don’t make money on the interest, so they have to charge points to earn their commission.
There are also wholesale mortgage lenders that offer the best of both worlds. Like brokers, they have access to various lenders and their programs. This allows them to shop your loan to get the most competitive pricing while not being pigeon holed into just a few mortgage programs. But they are still banks, so they don’t need to charge points. they earn their fee by wholesaling the mortgage to the primary lender.
You can buy a house with a 580 credit score if you have enough income and assets to qualify for the mortgage. You just need to know where to take your application to improve your chances of approval.
Yes, you can expect to pay more at first, but you will have the opportunity to refinance once you boost your credit scores.
Alternatively, you could work on improving your credit scores first to save money in the long run.