Mortgage shopping with a 640 credit score? You have options

Michele Lerner
The Mortgage Reports contributor

How to buy a home with a 640 credit score

Most home buyers know that they need “good” credit to qualify for a mortgage, but not everyone understands why a good credit score matters or the number they need to reach to be “good.”

Most mortgage lenders have a range of scores they categorize as excellent, good, fair or poor. Not only does your credit score affect your chances of getting approved for a home loan; it determines how much you’ll pay for it.

Verify your mortgage eligibility with a 640 score (Sep 23rd, 2021)

How good is a 640 credit score?

According to FICO, the average credit score in April 2016 was 699, so a FICO score of 640 is below average. Generally, “fair” credit scores range from 620 to 679. Applicants with a score below 620 are considered high-risk, and will have trouble qualifying for a home loan.

Many lenders set their minimum credit score at 640 or higher. That’s a minimum, which means applicants at the low end, credit-wise, may need to be strong in other aspects, like down payment size, income or assets.

Loan programs for fair credit scores

A fair credit score won’t necessarily disqualify you, but you may have to pay more for your mortgage.

In most cases, government-backed loans have more forgiving guidelines.

In most cases, applicants with lower credit scores pay more than those with higher scores.

1. Conforming mortgages

The term “conforming” means mortgages offered by Freddie Mac and Fannie Mae lenders. They conform to guidelines established by the government and these corporations.

Conforming loans require at least a 620 credit score. Minimums can run higher, though, depending on your down payment and debt-to-income ratio.

To qualify with a 640 FICO score, your down payment must be at least 25 percent. For smaller down payments, the minimum credit score increases to 680 or 700.

Conforming lenders also charge you a higher interest rate for a lower score. They call it a “risk-based pricing adjustment.”

Verify your conforming loan eligibility. (Sep 23rd, 2021)

2. FHA home loans

FHA loans are government-backed mortgages, and they don’t have risk-based pricing adjustments.

The minimum credit score established by the Federal Housing Administration for its insured loans is 500, but if you’ll need to make a down payment of at least 10 percent.

FHA’s 96.5 percent loans with 3.5 percent down payments require a minimum FICO of 580.

In addition, FHA lenders are allowed to impose higher minimums, and many do. Lenders do this in order to reduce their foreclosure rate.

Verify your mortgage eligibility (Sep 23rd, 2021)

3. VA home loans

VA home loans are a government benefit available only to eligible active military members, veterans, some surviving family members, Reservists and the National Guard.

Another advantage is that VA loans require no down payment at all.

The government doesn’t set a minimum credit score, but many lenders do. A 640 FICO can get you approved for a VA home loan if your income is sufficient to qualify.

4. USDA home loans

USDA loans are also called Rural Housing loans. To be eligible, the property must be located in a designated rural area. However, the definition of “rural” is loose. Many suburban neighborhoods across the U.S. are eligible.

In addition, the borrower’s income cannot exceed certain limits, which depend on the Area Median Income (AMI).

The minimum credit score in most cases is 640, but in rare cases can go as low as 580.

See if you can qualify for a USDA home loan. (Sep 23rd, 2021)

5. Credit unions

Many credit unions have no established minimum credit score for borrowers, who must be members of the credit union.

However, credit unions are owned by their members and known to lend rather conservatively.

6. Non-prime and non-QM loans

Some mortgage lenders don’t sell their loans to investors, and can largely make their own rules. These lenders are called “portfolio lenders,” and some offer loans with low credit score requirements.

Loans for borrowers with fair or low credit scores may be called “non-prime” or “non-QM” mortgages.

One San Diego-based lender, for example, allows FICO scores as low as 500 with at least 20 percent down. These loans come with significantly higher interest rates.

Lender Overlays

Although it appears that a credit score of 640 shouldn’t block you from getting a mortgage, lenders and their investors decide for themselves their appetite for risk.

Some lenders simply set their minimum credit score higher to avoid loaning money to someone they consider risky. In addition, lenders use risk-based pricing, which means that they charge higher interest rates for lower FICO scores.

Lenders can add additional “overlays” to their loans, such as requiring extra cash reserves or larger down payment for a loan approval, or charging a higher interest rate or higher fees to borrowers with fair credit.

How to compensate for a fair credit score

If you don’t want to wait until your FICO score improves, you can make your application more attractive to lenders in several ways:

Make a bigger down payment.

A down payment of 20 percent or more makes you a stronger candidate for a loan, because you already have built-in home equity. In addition, a bigger down payment gets you smaller mortgage payments.

Increase cash reserves.

If you can document that you have several months of mortgage payments (three to six month is often considered helpful) in the bank, lenders have more confidence that you can repay your loan if you have a cash crunch.

Eliminate payment shock.

Payment shock happens when your new housing payment is much higher than your old one. Your approval chances increase if you’ve been comfortably paying rent or a previous mortgage in an amount similar to your new payment.

Reduce your debt-to-income ratio.

Your debt-to-income ratio compares the minimum monthly payment on all your current debt, including your mortgage, to your gross (before tax) monthly income. Anything over 41 percent is considered high by many lenders, so lower is better.

If you apply and get turned down for a mortgage, it’s not the end of the world. Ask your lender what you’d need to do to change your denial to an approval. Or simply find another lender with more forgiving guidelines — they’re out there.

What are today’s fair credit mortgage rates?

Mortgage rates today are so low that even if you pay a little more for having a fair credit score, you’ll still be getting a historically good interest rate.

Verify your mortgage eligibility (Sep 23rd, 2021)