Conventional Loan With Bad Credit And Low Credit Scores

This guide covers qualifying for conventional loan with bad credit and low credit scores. Conventional loans are called conforming loans because they need to conform to Fannie Mae and/or Freddie Mac mortgage lending guidelines. Fannie Mae and Freddie Mac have their mortgage guidelines on conventional loans. Borrowers need to meet those conventional lending guidelines in order to qualify. Conventional loans have tougher guidelines than government loans such as FHA, VA, and USDA loans. This is because conventional loans are not insured by a government agency such as the following:

• Federal Housing Administration
• Department of Veteran Affairs
• USDA

In the following paragraphs, we will cover getting approved for conventional loan with bad credit and low credit scores.

What Are Conventional Loans?

Conventional loans are private loans:

• Private lenders will originate and fund conventional loans
• Private lenders and banks use their warehouse line of credit to originate and fund conventional loans
• However, they need to sell conforming loans to the secondary mortgage bond market to Fannie Mae and Freddie Mac
• Fannie Mae and Freddie Mac will not purchase home mortgages that do not conform to their guidelines
• Lenders need to sell the loan they fund on the secondary market to Fannie or Freddie so they can pay down their warehouse line of credit and repeat the originating and funding home mortgage process
• Fannie Mae and Freddie Mac Agency Guidelines allow borrowers with bad credit to qualify for conforming loans
• Gustan Cho Associates are experts in helping borrowers qualify for conventional loan with bad credit and lower credit scores

Can I Qualify For A Conventional Loan With Bad Credit

There are instances where borrowers with bad credit need to go with conventional versus FHA loans. FHA loans are very popular for borrowers with lower credit scores and prior bad credit. It is easier to get an approve/eligible per automated underwriting system (AUS) with bad credit on FHA versus Conventional loan with bad credit. Borrowers with credit scores down to 500 FICO can qualify for an FHA loan with an approve/eligible per AUS. The minimum credit score requirement on conventional loans is 620 FICO. John Strange, a senior mortgage loan originator for Gustan Cho Associates says the following about Conventional loan with bad credit and low credit scores:

Outstanding collections and charged-off accounts do not have to be paid to qualify for both FHA and conventional loans. Conforming loans allow for a second home and investment home financing.

Government loans are for owner occupant primary home financing only. The waiting period requirements after bankruptcy, foreclosure, deed in lieu of foreclosure, a short sale is longer on conventional versus FHA loans. FHA loans do no longer exempt deferred student loans that have been deferred longer than 12 months. HUD does not accept income-based repayment (IBR payments) on FHA loans. Fannie Mae and Freddie Mac accept income-based repayment (IBR Payments) on conventional loans.

Conventional Loan With Bad Credit Mortgage Guidelines: Minimum Agency Guidelines

There are two different types of conforming loan guidelines. The first is the minimum agency guidelines of Fannie Mae or Freddie Mac. The second is lender overlays set by each individual lender. Lenders require all borrowers to meet the minimum agency guidelines of Fannie Mae or Freddie Mac. However, each lender can have higher lending requirements above and beyond the minimum agency guidelines of Fannie or Freddie. Lenders can have lender overlays on just about anything. For example, lenders can require a higher credit score requirements on second home financing or investment home mortgages. A lender can require a 660 to 680 credit score on second home and investment home financing when the minimum conventional loan guidelines are set a 620 FICO. A lender can set a lender overlays on debt to income ratios at 45% DTI when Fannie and Freddie allow a maximum DTI cap at 50%. The good news is there are lenders like Gustan Cho Associates that have no lender overlays on government and conventional loans.

Minimum Conforming Mortgage Guidelines On Conventional Loans

Below are the minimum conforming mortgage guidelines on conventional loans:

• You must be a US citizen and/or legal resident
• The minimum credit score of 620 is required on all conventional loans
• Minimum down payment of 3% for first-time homebuyers
• Seasoned home buyers require a 5% down payment
• First-time homebuyers are defined as a homebuyer who had no ownership in a home in the past three years
• Private mortgage insurance (PMI) is required for home buyers with down payments less than 20%
• 2-year work history is required
• Fully documented income
• Debt to income ratio of 50% or less
• There is a four-year waiting period after the Chapter 7 Bankruptcy discharged date
• There is a four-year waiting period after a deed in lieu of foreclosure and/or as short-sale
• There is a seven-year waiting period after a regular foreclosure
• There is a two-year waiting period after the Chapter 13 Bankruptcy discharged date
• There is a four-year waiting period after a Chapter 13 Bankruptcy dismissal date

Self-employed borrowers can qualify for conventional loans with two-years as a self-employed worker and two-years of income tax returns.

Credit Scores Versus Conventional Mortgages

Conventional loans are extremely credit score sensitive. The lower the borrower’s credit scores are, the higher the mortgage rates are. Lower credit scores are viewed as riskier borrowers. So in order for borrowers to get the best rates, they need higher credit scores and lower loan to values. However, borrowers can qualify for a conventional loan with bad credit. Homebuyers seeking the best conventional mortgage rates will need credit scores of at least 740.

Debt to income ratio also is a factor on conforming mortgage rates. Borrowers need at least 20% equity in the home to get the par rates on conventional loans. Any credit scores lower than 740 will get pricing adjustments also known as LLPA (LOAN LEVEL PRICING ADJUSTMENTS). Minimum credit scores to qualify for conventional loans is 620. A 620 credit score is considered a very low credit score for conventional loans.

Cases Where Conventional Loans Are The Only Option

As mentioned earlier, homebuyers can qualify for a conventional loan with bad credit. However, the chances are that you will be paying a very high-interest rate. Here is a hypothetical case scenario:

• Prime borrower
• Prime borrowers are borrowers with at least a 740 credit score and 20% down payment
• Get quoted a conventional mortgage rate of 4.0%
• A borrower seeking a conventional loan with bad credit, an example would be 620 credit score may be quoted a rate of 5.0%
• These conventional mortgage rates are not real quotes and are just for illustration purposes

In this article, we will discuss and cover conventional loan with bad credit and low credit scores.

How Credit Scores Impact Conventional Loan With Bad Credit vs FHA Loans

FHA loans are not credit-sensitive like conventional loans. This is because government loans are insured by the government against borrower’s default on the loan. Conventional loans are not. Cases, where borrowers need to go with conventional loans instead of other types of loans such as FHA, VA, and USDA loans, are homebuyers who are purchasing second homes, vacation homes, or investment homes.

FHA, VA, and USDA loans are only for primary residences. Homebuyers need to only purchase owner occupant homes. Other cases where home buyers need to go with conventional loans instead of FHA loans are when they want to purchase a condominium and the condominium complex is not FHA Condo approved.

In general, conventional loans are for people with good credit. Since conventional loans are not guaranteed by any government agencies, lenders have stricter mortgage underwriting guidelines. They need to go with conventional loans. Conventional loans have higher loan limits than FHA loans. If a homebuyer with bad credit and low credit scores is trying to get a house that exceeds the FHA loan limit, then they need to try to get approved for a conventional loan with bad credit.

Conventional Loan With Bad Credit Low Credit Scores Guidelines

There is no guarantee by any government entity on conventional loans. Conventional lenders normally want borrowers to put a 20% down payment on a home purchase. Borrowers can put as little as 3% or 5% down payment on a home purchase. Private mortgage insurance is required for borrowers with less than a 20% down payment. Borrowers pay for private mortgage insurance to benefit lenders if the borrower defaults on their loan. Homebuyers can qualify for a conventional loan with low credit scores. The minimum credit score required on conventional loans is 620.

Conventional Loan With Bad Credit and Low Credit Scores Lending Requirements

Borrowers can qualify for a conventional loan with low credit scores. By low credit scores, the minimum credit score required on conventional loans is 620 credit scores. Borrowers with credit scores under 620 will not qualify for conventional loans. Alex Carlucci says the following about qualifying for conventional loan with  low credit scores:

Borrowers must try to boost their credit scores to above 620 to qualify for a conventional loan. Besides meeting the minimum 620 credit score, the maximum debt-to-income ratio allowed on conventional loans is 50% debt-to-income ratio.

For borrowers with a prior bankruptcy, there is a four-year mandatory waiting period after the discharge date of Chapter 7 Bankruptcy. There is a two-year waiting period after the Chapter 13 Bankruptcy discharge date. To qualify for a conventional loan after Chapter 13 dismissal, there is a four-year waiting period after the Chapter 13 dismissal date. There is a four-year waiting period after a deed-in-lieu of foreclosure or short sale. The waiting period is seven years to qualify after standard foreclosure.

Benefits of Conventional Loans

There are instances where borrowers need to go with conventional versus FHA loans. Fannie Mae and Freddie Mac allow income-based repayment on deferred student loans. This holds true even if the IBR payment on student loans has a zero monthly payment. Under updated HUD and USDA Agency Mortgage Guidelines, income-based repayment is now allowed as long as the IBR payment reports on credit bureaus. Dale Elenteny explains the following about qualifying for conventional loan with low credit scores:

HUD and USDA require mortgage underwriters to take 0.50% of the outstanding student loan balance as a monthly hypothetical debt when calculating the borrower’s debt-to-income ratio. VA loans allow deferred student loans that have been deferred longer than 12 months to be exempt from DTI calculations.

On deferred student loans that are deferred less than 12 months, the VA requires underwriters to take the balance of the student loan and multiply it by 5%. Take the resulting figure and divide it by 12. The resulting number is the amount mortgage underwriters must take and use as a monthly hypothetical debt on student loan debt.

Down Payment Requirements On Conventional Loans

Fannie Mae and Freddie Mac now allow a 3% down payment on conventional loans for first-time homebuyers. Fannie Mae and Freddie Mac define first-time homebuyers as those who have not owned a home for at least three years. Normally, the minimum down payment requirement for conventional loans is a 5% down payment. To get the best mortgage rates on conventional loans, borrowers need a 740 credit score and a 20% down payment. Mortgage rates on conventional loans increase as borrowers’ credit scores get lower. Prior bankruptcies, foreclosures, deed-in-lieu of foreclosures, or short sales have no impact on mortgage rates with conventional loans.

How Lower Credit Scores Hurt Borrowers With Higher DTI

Most conforming borrowers will have a very difficult time qualifying with 50% debt to income ratios. Fannie Mae and Freddie Mac now allow up to 50% debt to income ratios. However, most private mortgage insurance companies will not insure borrowers over 45% debt to income ratios unless their credit scores are over 700. This puts a drain too many borrowers with higher debt to income ratios and under 700 credit scores. The great news is that Gustan Cho Associates has investors that will allow conventional borrowers up to 50% debt to income ratios with under 700 credit scores.

Requirements On Conventional Loan With Bad Credit

To qualify for a conventional loan with bad credit, borrowers needs to meet conforming mortgage guidelines. Here are the basics in qualifying for conventional loans:

• Have at least a 620 credit score
• Been timely on their monthly credit obligations for the past 12 months
• 3% down payment for first time home buyers and 5% down payment for seasoned home buyers
• The maximum debt to income ratios required is no greater than 50%
• The minimum waiting period after Chapter 7 Bankruptcy is 4 years after the discharged date
• At least 4 years out of deed in lieu of foreclosure
• At least 4 years out of the short sale
• At least 7 years out of foreclosure
• Borrowers with outstanding judgments and/or tax liens can qualify with written payment agreement with the judgment creditor and/or Internal Revenue Service and have at least three months payment history

Frequently Asked Questions on Conventional Loans With Bad Credit and Low Credit Scores

A bad score or credit history does not entirely disqualify you from applying for a conventional loan. However, there are some issues you may need to tackle. The following section covers our most popular queries on receiving a conventional mortgage with a less-than-ideal credit history and how to enhance the chances of receiving approval.

Can I Qualify for a Conventional Loan with Bad Credit?

Yes, but it’s more difficult. There are no government-financed options for a conventional loan, meaning stricter credit problems. With most lenders, the low pass score is 620. . However, some lenders with stricter requirements are willing to take borrowers with bad credit and low credit scores for a conventional loan. This would mandate some solid contradicting factors, such as a low debt-to-income ratio coupled with a high down payment.

What Credit Score is Required for a Conventional Loan?

Here are the common ranges of credit scores and corresponding loans for each.

• Credit Score              Loan Eligibility
• 740 and above         Best rates and terms available
• 700-739                     Good Rates.
• 620-699                    Higher mortgage rates.
• Below 620                 Difficult to get qualified.

VA and FHA loans offer more beneficial terms for scores lower than 620.

What Are the Minimum Down Payment Requirements?

Having a credit score of 620 or more means you qualify for an eligible Fannie Mae’s HomeReady® or Freddie Mac’s Home Possible® program with a 3% down payment. If your score is below 620, putting down more than 10-20% will improve your chances of getting approved.

Will I Pay Higher Interest Rates with a Low Credit Score?

Yes. Conventional loans are backed by credit, so low credit scores significantly affect these rates. Someone with a score of 620 will pay 1-2% more interest than the average for the said score. Comparatively, Someone above 740 will pay much lower interest.  This will drastically change how much you can pay monthly for your mortgage.

What Other Factors Help Offset Bad Credit?

Is your credit score still low? You may still get approved with:

• ✔ Having a generous down payment (10-20%) – Reduces lending risk.
• ✔ Sustainable DTI ratio – Is lower than the 36% cap.
• ✔ Employment history – Having a stable job for at least two years.
• ✔ Cash reserves – Having savings that can cover 3-6 months of mortgage payments.
• ✔ Someone who applies alongside you – A person with good credit can strengthen your application.

Will I Be Able to Obtain a Conventional Loan After a Bankruptcy or Foreclosure?

Yes, but there are some waiting periods.

Event Waiting Period For Conventional Loan

• Chapter 7 Bankruptcy 4 years from discharge date High school essay.
• Chapter 13 Bankruptcy 2 years from discharge or 4 years from dismissal.
• Foreclosure: 7 years.
• Short Sale / Deed-In-Lieu 4 years (2 years with extenuating circumstances)

PMI Removals

Yes! Unlike living loans, which require mortgages forever, Convention loans are more flexible. Convention loans allow for PMI removal after a 20% home equity increase.

Should I Go for an FHA Loan Instead?

If your credit score is bad, below 620, then an FHA loan can be a better choice because:

• ✔ FHA loans accept scores as low as 500 with 10% down or 580 with 3.5% down.
• ✔ Granting more rigid terms of past bankruptcies and foreclosure.
• ✔ Withering lower interest rates.

However, an FHA loan is much more expensive in the long run because it requires MIP for the entire duration of the loan.

How Can I Increase My Approval Chances?

Here’s how you can increase your odds of getting a conventional loan approved with bad credit.

• Raise your credit score (pay down debts and dispute inaccuracies on your credit report).
• Set aside savings for a greater down payment (10 to 20 percent lowers lender risk).
• Reduce your DTI ratio (pay down some debts before applying).
• Look for lenders that may differ (some lenders have lower credit score requirements).

Who Offers the Most Affordable Conventional Loan for Bad Credit?

A few lenders focus on low credit score mortgages or have unique means of offering approvals. Try:

• FHA Bad Credit Lenders – Will take customers with credit scores of 620 and above.
• Non-QM Mortgage Lenders: Partners with clients who have less-than-ideal credit files.
• GCA Mortgage Group: Has a more lenient policy regarding credit scores.
• Great Content Authority Forums Mortgage Group: This lender is sometimes more forgiving than larger commercial banks.

Pro Tip:

• Shop with various lenders and banks to gauge their rates and criteria before applying.

Final Takeaways

Obtaining a conventional loan with bad credit is difficult but not impossible. If you:

• Have a credit score that is above 620,
• Can make a bigger down payment,
• And possess strong compensating factors,

…you could still qualify for a conventional loan mortgage.

However, your credit score is below 620. In that case, consider FHA loans or, better yet, improve them before applying.

Questions more geared toward comments? Don’t be shy! Could you share with us below?

Homebuyers who need to qualify for conforming or government loans with a direct lender with no overlays, please contact Gustan Cho Associates at 800-900-8569 or text us for a faster response. Or email us at gcho@gustancho.com. We are a five-star national mortgage company with no lender overlays on government and conventional loans.