Kenneth Harney at The Real Deal writes, “If you’ve got a low FICO credit score but believe you can handle monthly mortgage payments instead of rent, here’s some potentially good news: The government is now willing to give you a better shot at obtaining a low-down-payment home loan from the Federal Housing Administration. Under a key policy change that took effect last week, lenders nationwide now have more leeway to approve mortgages to borrowers who qualify under FHA’s underwriting guidelines but may have below-par FICO scores.”
The article explains FICO credit scores run from 300, considered the highest risk of default, to 850, the lowest risk. Though FHA for years has accepted applicants who have FICO scores in the 500s, the practical reality has been that most lenders ignore borrowers whose scores are under 620 or even 640.
How is your FICO score calculated? Your score is based on many different pieces of credit data in your credit report. This data is grouped into five categories as outlined below. The percentages in the chart reflect how important each of the categories is in determining how your FICO Scores are calculated.
The best advice for rebuilding credit is to manage it responsibly over time. If you haven’t done that, then you need to repair your credit history before you see credit score improvement.
If you don’t know your FICO score, you can request a free copy of your credit report then check it for errors, such as late payments incorrectly listed for any of your accounts and that the amounts owed for each of your open accounts is correct. If you find errors on any of your reports, dispute them with the credit bureau.
Got a Low FICO Credit Score?
Making your credit payments on time is one of the biggest contributing factors to your credit scores. Set up reminders for making payments or switch from paying by check to automatic bank debits to each creditor.
Get out of debt. Reducing the amount that you owe is going to be a far more satisfying achievement than improving your credit score. The first thing you need to do is stop using your credit cards. Then come up with a payment plan that pays off the cards. Once credit card debt is gone, build an emergency fund equal to six months living expenses. Finally, save large amounts of money going to interest by paying off your mortgage early.
Here are the payments for a $300,000 mortgage. (These examples are mortgage payments only, excluding taxes and insurance.)
If your budget can accommodate the higher payment on the 15-year loan, not only will you pay your loan off early, but your interest rate is .625 percent lower, saving you $102,732 in total interest paid over the life of the loan.
Even better, if you make an extra payment of $300 each month, you can pay down the mortgage faster. For example, a fifteen–year mortgage can be paid off in 5 years and three months; an extra payment of $400 each month reduces the fifteen year mortgage to three years and four months. That’s not all. You would save $59,781 in interest when you pay $300 extra and $70,949 with an extra $400 per month. To me and I hope to you, that’s big money.
If you are ready to make the leap to owning a home and you have a low FICO score, shop around. You may get turned down by some lenders because they haven’t reduced their standards yet. Keep shopping until you find one that has. You are likely to find a better reception than you expected.
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