You can get a home loan with a surprisingly low credit score, but there’s good reason to aim higher.

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There was a time when you could get a mortgage, regardless of what your credit score was. There were no-credit loans, loans for people without incomes or assets, and even home loans for people who had recently declared bankruptcy.

Unfortunately,these lax lending standards were a major contributor to the near-collapse of the U.S. financial system in 2008. Lending standards have tightened considerably since then. In order to get a mortgage now, you need to be able to document your ability to pay it back, and mortgage lenders want to see a reasonably good credit history.

Having said that, you don’t need an excellent FICO® Score to get a mortgage. In fact, if your employment, assets, and other qualifications justify the loan, you might be surprised with the minimum FICO® Score requirements for mortgage loans.

The minimum FICO credit score for a conventional mortgage

A conventional mortgage is the most common type of home loan. This term refers to mortgages that meet the underwriting standards of Fannie Mae or Freddie Mac.

The short answer is that the minimum FICO® Score required for a conventional mortgage is 620. However, this is the bare minimum. Depending on the borrower’s down payment, reserves, and other debts, the minimum score can be as high as 700 according to Fannie Mae’s latest underwriting standards.

FHA mortgages have even lower credit standards

An “FHA mortgage” refers to a mortgage that is insured by the federal government. In order to be eligible for an FHA mortgage, borrowers must have at least two established credit lines, a debt-to-income ratio (DTI) of 31% or less excluding the expected mortgage payment, and no delinquent federal debts.

As long as those requirements are met, borrowers can be eligible for FHA loans with rather low credit scores. FHA loans with a rock-bottom 3.5% down payment are available with FICO® Scores as low as 580, which is generally considered to be on the higher end of “poor” credit. And if a borrower can come up with at least 10% down, the FICO® Score requirement drops to 500.

It’s important to mention that lenders don’t necessarily need to adhere to these minimums and can set their own standards, as long as they are in excess of the scores mentioned here. For example, a mortgage lender that offers FHA loans could potentially set their own minimum FICO® Score requirement at 600, not 580, for the low-down-payment version of the FHA loan.

The caveat to FHA loans is that the mortgage insurance is expensive. FHA loans have ongoing mortgage insurance premiums in the range of 0.45% to 1.05% of the loan balance per year, which is competitive with the private mortgage insurance (PMI) conventional borrowers with less than 20% down can expect. However, FHA loans also have an upfront mortgage insurance premium of 1.75% of the loan amount. With a $250,000 loan, this translates to $4,375 -- not a small amount of money. Plus, while conventional borrowers can drop PMI once the loan is paid down to 80% of the purchase price, FHA mortgage insurance is permanent in most cases.

It’s not just about your credit score

Your credit score is certainly an important factor in obtaining a home loan, but it is just one piece of the puzzle. In addition to your FICO® Score, your mortgage lender will consider:

• Your down payment -- While the minimum down payment for a conventional loan is 3% for first-time buyers, higher down payments can increase your chances for approval, and can also lower your interest rate. Plus, it’s worth mentioning that a down payment of less than 20% will likely require you to pay for private mortgage insurance, or PMI.
  
  

• Your income -- Lenders want to know that you earn enough money to justify the loan. Generally speaking, lenders want to see that your new housing payment will make up less than 28% of your pre-tax income and that your total debts (including your mortgage payment) will be less than 45% of your income.
  
  

• Your assets -- If you have substantial money in savings, lots of investments, or other assets, it can help bolster your mortgage application. In fact, lenders generally require that you have a certain number of mortgage payments (say, six months’ worth) in reserve.
  
  

• Your employment history -- Not only does your lender want to see enough income to justify the loan, but they want to know that your income is likely to continue for the foreseeable future. As a general rule, lenders want to see at least two years of steady employment in the same industry, with no significant gaps.

In order to qualify for a mortgage with a credit score close to the minimum, you’re likely to need very strong qualifications in the other areas.

For example, according to Fannie Mae’s latest underwriting guidelines, in order to qualify for a mortgage with a 620 FICO® Score, you’ll need either:

• A total debt-to-income (DTI) ratio of 36% or less, and a down payment of at least 25% of the purchase price.
  
  

• A DTI of 45% or less, but also with a down payment of at least 25% and two months’ worth of mortgage payments in reserve.

The credit scores and other qualifications of actual mortgage borrowers

Most mortgage borrowers have significantly higher credit scores than their particular loan program requires. As of October 2018, the average homebuyer who obtained a conventional mortgage had a FICO® Score of 751, according to Ellie Mae -- a score largely considered to be great credit.

What’s more, the average buyer put 20% down and had an overall debt-to-income ratio of 37%. This is more money down than a conventional loan requires, and is also a significantly lower DTI.

Even for an FHA loan, the average borrower has a 676 FICO® Score -- generally considered to be good credit, and significantly above the minimum requirement. The average FHA borrower only put 5% down and had a relatively high 44% DTI, which makes sense, as FHA loans are typically used by borrowers with little cash to put down.

Here’s why you should aim for a higher credit score than your loan requires

Just because you can qualify for a conventional mortgage with a 620 FICO® Score, or an FHA loan with a FICO® Score in the 500s, doesn’t mean that it’s the best idea. FHA loans are expensive in general, and conventional lenders base your mortgage’s interest rate on your FICO® Score, among other factors. With a low FICO® Score, you could end up paying tens of thousands of dollars in additional interest on your loan, relative to a top-tier borrower.

Let’s put some numbers behind this. The median home sale price is $225,700 as of the latest available data, so with a 20% down payment (the average for a conventional loan), this implies a mortgage amount of $180,560. Here’s what type of mortgage payment this could translate to on a 30-year fixed-rate conventional mortgage, based on the latest average rates by credit score:

Data source: myFICO®. Rates as of 12/6/18.

Here’s the point. With a bare-minimum 620 FICO® Score, it’s possible to qualify for a conventional mortgage loan if the rest of your qualifications are strong. However, for an average mortgage amount, you’ll end up paying nearly $64,000 more in interest than a borrower with an excellent FICO® Score above 760 for the exact same house. Even jumping to the next tier could save you lots of money. So, if you have a borderline credit score, it could make sense to put your homebuying plans on hold for a bit and work on improving your credit score.

The bottom line on credit scores and home loans

To sum it up, you don’t need a great credit score to obtain a home loan. Otherwise well-qualified buyers can get a conventional mortgage with a FICO® Score of 620, while a FHA mortgage can be obtained with a FICO® Score of as little as 500.

Having said that, the stronger your mortgage application is, the lower interest rate you can expect. Since your credit score is a big piece of the mortgage approval puzzle, a better FICO® Score can translate into tens of thousands of dollars in interest savings over time.

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