Conventional Loan With Bad Credit And Low Credit Scores

This BLOG On Qualifying For Conventional Loan With Bad Credit And Low Credit Scores Was UPDATED And PUBLISHED On July 1st, 2020

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 Loans, VA Loans, 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

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 and/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 loans 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 loans
• 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
• 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 and/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 and/or Freddie Mac
• However, each lender can have higher lending requirements above and beyond the minimum agency guidelines of Fannie and/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.

FHA Loans Versus Credit Scores

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 Loans, VA Loans, USDA Loans, are homebuyers who are purchasing second homes, vacation homes, or investment homes
• FHA Loans, VA Loans, 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

They need to go with conventional loans.

Conventional Loan With 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 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

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.