mortgage

Can a low credit score sink your mortgage?

PMI and credit scores

Conventional loan borrowers who make a down payment of less than 20 percent also need to meet private mortgage insurance guidelines in addition to qualifying with the lender.

Here again, credit scores make a big difference in a borrower's ability to secure a mortgage.

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"Most PMI companies will not approve a loan for anyone with a credit score below 680," Benner says. "In addition, the amount of the loan they will insure changes based on the credit score. On some properties, such as a cash-out refinance or a second home, the PMI companies insist on a credit score of 720 or higher."

Nicholas says that in a declining market where home prices are still dropping, such as Michigan, PMI companies can require a credit score of 720 or higher.

How to overcome poor credit

Benner says borrowers with credit challenges should apply for FHA-insured loans.

"While FHA has not yet set a minimum credit score, most lenders will only qualify borrowers with a score above 620 and some have even set the minimum for FHA loans at 660," Benner says. "My company is one of the few that goes down to 540, but this depends on the consumer meeting other guidelines such as a reasonable debt-to-income ratio and savings."

The FHA has proposed limiting loan approvals to borrowers with credit scores of 500 and above and to require a 10 percent down payment from borrowers with credit scores between 500 and 579.

Another proposal would require borrowers with a credit score below 620 to have cash reserves of at least one month's mortgage payment available following the closing. Nicholas anticipates these changes to be in place in early 2011.

Borrowers who are turned down for an FHA loan through their automated system can request manual underwriting so that a live person reviews their loan application, Nicholas says.

"Be prepared with a letter of explanation for your low credit score, such as a one-time event or illness rather than a pattern of not paying your bills," Nicholas says.

Nicholas says if one lender won't do manual underwriting, another might.

Other compensating factors that can help a borrower overcome a low credit score include a low debt-to-income ratio, stable employment and substantial savings.

Benner says that FHA loans are available to all borrowers regardless of income or whether they are first-time homebuyers, as long as the home price meets area loan limits.

Another way to qualify for a mortgage when you have poor credit is to make a larger down payment.

"If you can put down more than 20 percent you won't have to meet PMI requirements," Benner says. "You may need to pay extra at the closing or a slightly higher interest rate, but you can qualify for a loan."

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