Lynette Asks: Dear Gina, I want to buy my first home and think I might have bad credit. Mortgage lenders seem to be changing their credit score requirements all the time. Cam you tell me what credit score I need to have to be approved for a mortgage?
If you have bad credit, refinancing a mortgage or buying a home isn't easy. And you are right; lenders have been changing their definition of what bad credit is and have been steadily raising the credit score they consider acceptable. For example, the average credit score of an FHA borrower increased month by month from 621 a couple of years ago to 693 as of October 2009.
It's difficult to come up with hard-and-fast rules about credit scores. Fannie Mae allows a score as low as 580 if you are willing to pay the surcharges associated with low credit scores and put up a large enough down payment. But don't expect to get approved with a 580 score, no assets, and a small down payment.
When you apply with a Fannie Mae lender, your application is analyzed electronically by Desktop Underwriter software, and the result is either "Approve," "Refer," or "Refer with Caution." When your credit score is low, you are unlikely to get an approval right off. A "Refer" grade kicks the application out for manual underwriting, and your credit history is examined more closely. If there were mitigating circumstances beyond your control, like an accident or serious illness, and you are now back to work and paying your bills on time, you could be approved. A "Refer with Caution" grade is very hard to overturn. You have to show that your credit information is inaccurate, for example, or you are a victim of identity theft. Freddie Mac's Loan Prospector software works in a similar fashion.
FHA is a little different. New guidelines specify that you need a score of 580 to qualify for a 3.5% down payment loan; otherwise you have to put up at least 10%. And if your score is below 500 you can't be considered for an FHA mortgage at all. But that's not the whole story. Just because your credit score meets FHA minimum standards doesn't mean that a lender won't require a higher score to approve your application.
Why should lenders have tighter guidelines than FHA requires? Why would they want to do less business than they otherwise could? It's because even if the lenders write loans in accordance with FHA guidelines, if they have a high incidence of defaults, they can lose their approval to do FHA business. And that is a big chunk of business to lose. So, while FHA may require minimum credit scores of 500, many lenders require 620, 640, or even 660.
Bad credit lenders used to fund home loans for people with bad credit with little regard for scores; they looked instead at the number of late payments, charge-offs, bankruptcy, etc. Some lenders still underwrite this way, but not many.
Your best bet (besides embarking on a plan to raise your score) is to shop with several lenders (try filling out the form on this site) and ask them what their minimum credit score requirement is. Then see which of the lenders willing to work with you offers the best deal.