Question: I have a 530 credit score and was told that I can get an FHA loan with a substantial down payment but the lender is giving me a hard time in getting the loan. What’s going on?
First, let’s understand what a 530 credit report looks like? Several factors can bring a score down that low (300 is the lowest). Perhaps the person has 1 credit card and 5 collection accounts that are currently reporting as delinquent. Almost always, collection account balances match the credit limit which further lowers the score. The person may have several collection accounts and no open credit lines. Low credit scores are a result of not enough open lines of credit, not necessarily that there are a lot of bad lines of credit.
Every bank has its own different guidelines. For the most part, it comes down to common sense. Put yourself in the bank’s position when determining lending money to someone. Example: the person has a recent bankruptcy followed by a foreclosure and all the credit cards are in default. Would you lend to someone with a credit profile like that? What if the person told you that the reason for the delinquency was due to loss of job, divorce or medical issue?
Lending in the future relies on how a person handled the credit situation. If the person lost his or her job and then regained employment, did he/she contact the creditors at the time and set up payment plans OR did the person wait until he/she decided to buy a house and then decided to pay off bad debt? Lenders don't like to see people waiting until the last minute to fix credit. During divorce proceedings, a judge can require a spouse to pay a debt but ultimately, both parties are responsible for the debt. If the ex-spouse doesn’t pay the debt, the other person is responsible. That’s just the nature of the beast. Medical reasons are a little more lenient when it comes to non-payment of debt. However, the medical reason has to result in loss of income. Being out of work for 1 month due to a medical issue does not mean that credit cards can be disregarded for 12 months. Usually, a creditor will not close an account if payments are not made for 1 or 2 months, especially if a letter is written to the company of the current situation. Creditors don’t make money when people don’t pay them.
I’ve worked with Professional athletes who make several millions of dollars a year. In many cases, their credit is very undesirable because they pay cash for everything and ignore their credit profile. Why have credit if you have cash? Well, maybe if you want to buy a $5 million house and you only have $1 million in the bank. Putting a lot of money down does not guaranty a loan. It guarantees the ability to apply for a loan and it may better the chances of getting a loan. If the person offers a large down payment with horrible credit, chances are, he/she will not get the loan.
All loans that are presented to underwriting with at least a 580 credit score, is sent through a process called AUS (Automated Underwriting System). The result will either be Eligible, Ineligible or Refer with Caution. Refer with Caution may recommend sending the loan through a manual underwriting process (this is worse than surgery without anesthesia). Most lenders do not offer manual underwriting for loans with a score below a certain number (600 for example). For those companies that offer manual underwriting, the borrower‘s information is going to be picked apart in a horrible, pain staking way.
An example of manual underwriting: Buyer has 1 credit card that is 11 months old – Credit card needs to be 12 months old (Eligible loans allow 1 credit card with 11 months of history). Buyer has a cash deposit of $1000 – Cash deposit cannot be used if not sourced (for eligible FHA loans, as long as the cash deposit is less than 1% of the sales price, it need not be sourced). Buyer living with relatives and not paying rent – Buyer must have a 12 month rent history (Eligible loans do not require rent history). Buyer obtaining a gift from relative – Buyer must have own funds (Eligible loans allow gift funds). As you can see, having a higher score well enough to obtain an Eligible determination, makes the lending process much easier.
Just because a lender can do a loan, doesn’t necessarily mean you can get the loan. The best thing to do is talk to a loan officer and find out your current credit situation (from all 3 bureaus). Start working on the credit issues and be patient on getting the scores up so that your chances of getting the loan are much greater.