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Poor credit is said to be one of the main things holding back the housing market. There are millions of willing buyers out there, the conventional wisdom goes, but they can't get a mortgage because of poor credit.

Or the closely related notion that lenders have tightened their standards so much, you can't get a mortgage unless you have excellent credit - and a hefty down payment besides.

Like so many other things, there's a bit of truth in this - but also a whole lot of exaggeration.

To be sure, lending standards are a lot tougher than they were 10 years ago, at the peak of the housing bubble. But back then, there were practically no standards at all. Bad credit, little income - it didn't matter, you could still find a lender who would write you a mortgage as long as you could sign your name.

Loans for Bad Credit Scores

Credit not a problem for most

But the difficulty of getting a mortgage today has been greatly overstated. Sure, you'll have a hard time obtaining a home loan if you've been through a recent foreclosure or bankruptcy, or if you have really poor credit - a FICO score in the 500s or below. But if you've got a score of 620 or better, you should be able to qualify for a mortgage as long as you have adequate income and aren't already burdened with existing debts.

That's a category that covers more than three-quarters of all consumers - meaning the vast majority of people have adequate credit to qualify for a mortgage. Consider this: according to the Fair Isaac Co., developer of the FICO credit scoring system, that as of 2013:

  •  37 percent of consumers have "perfect" credit, with scores of 750 or better.
  • 53 percent have scores of 700 or above - the usual definition of "good" credit or better.
  • Another 23 percent have scores in the 600 range, usually defined as "fair" credit.
  • Only 24 percent have scores in the 500s or below, the range thought of as "poor" credit.

 

Not only that, but those figures are almost exactly identical to the distribution of credit scores back in 2005, at the peak of the housing bubble! So credit scores have pretty much returned to normal following the Great Recession; in fact, they're probably a bit better than that, since 2013 is the most recent year for which scores are available.

What about so-so credit?

So what kind of mortgage can you get with a credit score in the 600s? If you're in that range, your best bet is likely going to be an FHA home loan. The FHA will approve mortgages with only 3.5 percent down for borrowers with credit scores as low as 580. You can go even lower than that if you can afford a down payment of 10 percent or more.

However, most FHA lenders won't go that low. Many won't go lower than 620 on a mortgage application with 3.5 percent down, and won't even consider a sub-580 score. But the key word here is "most" - that doesn't mean "all." If you're in the sub-620 range, you can still get an FHA mortgage, but you may have to hunt around a bit for an FHA lender who'll approve you. Different lenders have different approval standards.

One of the best things about an FHA loan, if you've got a 600-range credit score, is that the FHA doesn't use risk-based pricing. That means you don't have to pay a higher interest rate just because you've got a lower credit score.

On conventional mortgages, the ones backed by Fannie Mae and Freddie Mac, your interest rate goes up as your credit score goes down - so that a borrower with a score in the lower-to-mid 600s may end up paying a rate 1 to 1.5 percentage points higher than a borrower with "perfect" credit. So while Fannie and Freddie mortgages can be a good choice for people with credit scores above 700, FHA loans are frequently the more popular option for those with only "fair" credit.

Don't you need a high score?

But wait a minute, you might say. What about those reports showing that borrowers who that show that borrowers approved for FHA loans have an average credit score around 680, and those with Fannie/Freddie loans average over 750? Doesn't that suggest those are the scores you need to get those types of loans?

Not really. Remember, those are averages, so there are borrowers approved both above and below those scores. Also, recall from above that 37 percent of borrowers have scores above 750 and more than half are over 700. Less than a quarter are in the 600 range. So that's going to drive the averages up.

Keep in mind that credit scores aren't the only thing lenders look at when approving a mortgage application. Many are rejected for a high debt-to-income ratio. But people who carry a lot of debt tend to have lower credit scores. So when they get rejected due to their debt load, that drives up the average score of those who are approved. But simply having a so-so credit score won't count you out if your debts are under control.

People also get turned down because they house they've chosen won't appraise for the price they've agreed to pay. Or because they don't make enough money to adequately cover the payments on the home they've chosen. In the latter case, that's sometimes because they've taken too many deductions on their income taxes, which reduces their reported income. That's often an issue with business owners or other self-employed people - but it has nothing to do with credit score.

Those people often have high credit scores - but they still get turned down for other reasons. That doesn't mean you will.

It's the total picture that counts

Mortgage applications and approvals are individualized. Your lender will look at your entire application - your credit score, level of debt, income, the home appraisal and everything else. They typically want to see a monthly mortgage payment (including taxes and insurance) of no more than 28 percent of your monthly income, and total debt payments of no more than 41 percent.

If you meet those standards and your chosen home appraises for the price you're paying, you've got an excellent shot at getting approved, even with a credit score that's only so-so.

Published on July 10, 2015