If you have a low credit score due to a lack of credit history should you apply for a mortgage now or wait?

By Michael Jensen, Mortgage and Finance Guru

Edited by Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Updated October 20, 2020

The answer to your question depends on your specific credit score and your financial priorities.  If you meet the minimum credit score requirement and your primary goal is to buy a home, then you should apply for the mortgage now.  If you do not satisfy the score requirement and your timing is more flexible, you may be able to qualify for better mortgage terms if you wait.  We review both scenarios below so you can decide the approach that is right for you.

If you want to buy a home sooner rather than later, the key question is: is your credit score high enough to qualify despite your limited credit history?  In this case, an FHA mortgage may be your best option because it requires a credit score of only 500 if you make a down payment of at least 10% and a score of 580 if you put down between 3.5% and 10% of the property purchase price .

Benefits of the FHA program include a low down payment, more flexible qualification guidelines and lower mortgage rates as compared to a standard conventional loan, regardless of your credit score.  Drawbacks of an FHA mortgage include loan limits plus you are also required to pay an upfront and ongoing mortgage insurance premium (MIP) which increases your closing costs and monthly payment.  Additionally, the mortgage insurance for most FHA loans is non-cancellable which means you are required to pay it for your entire loan term.  

If you have a credit score of at least 620 and scores from at least two of the three main credit bureaus, you may also be able to qualify for a conventional mortgage.  The key advantage of a conventional mortgage is that you are not required to pay mortgage insurance if you make a down payment of at least 20%.

You can also get approved for a conventional mortgage with a down payment of only 3% but the eligibility requirements are more challenging than for an FHA loan.  Plus, if your down payment is less than 20% you are required to pay monthly private mortgage insurance (PMI), as long as your loan-to-value (LTV) ratio is above a specified level, which is usually 78% to 80%.  The good news is that once your LTV ratio is below this level -- because you paid down your loan balance or your property value improved -- the PMI is removed from your mortgage, which reduces your total monthly housing expense.

The main negative of a conventional loan is that applicants with lower credit scores are usually required to pay a higher mortgage rate.  The higher your rate, the higher your monthly payment and lower the loan amount you can afford.  Please note that if you have credit scores from two bureaus the lender uses the lower score to determine your mortgage terms while if you have three scores, the lender uses your middle score.

Assuming you meet the minimum credit score guidelines outlined above, as a first step, I recommend that you contact multiple lenders in the table below to compare loan terms, including interest rates and mortgage insurance.  When you reach out to lenders, request both FHA and conventional mortgage proposals so that you can compare the monthly payments and the loan amounts for each program.  Reviewing this information can help you select the lender and program that are right for you.

If your timetable for buying a home is more flexible, your other option is to wait several months until you have developed your credit history, assuming you pay your bills when due and keep your credit usage relatively low. If your credit score increases, you may be able to qualify for better mortgage terms which reduces your monthly payment or increases the loan you are eligible for.

If you decide to wait, I also recommend that you consider obtaining another credit card with a relatively low borrowing limit but not use the card. Sometimes having at least two loan accounts, such as credit cards, can boost your credit score even if you do not use one the cards. This is because you have further established your credit history plus you have access to additional borrowing capacity.

So your financing alternatives are to apply for the mortgage now and potentially pay a higher mortgage rate or wait to apply and potentially benefit from an improved score.  Waiting may also enable you to save more money for your down payment or closing costs. 

The negatives of waiting are that there is no guaranty that your credit score will increase or how long it takes for your score to change.  Waiting also exposes you to the risk that mortgage rates increase over the next several months, which is out of your control. So even if you wait and your score improves, rates could increase due to market conditions and you could end up with the same loan terms.

One option is to apply for the mortgage today and buy the home you want. If your credit score improves in the future you could potentially refinance your mortgage at a lower interest rate if you wait at least six months after your loan closes. It is important to reiterate that no one really knows what interest rates will be in the future but this is one possible scenario available to you.  My preliminary advice is that you apply for the mortgage now but the answer for your really depends on your individual circumstances.

If you are interested in buying a home in the near term, I recommend that you get pre-approved for your loan.  This enables you to move with greater certainty when you shop for a home whether that is now or in the future.

Sources

"II.A.1.b.ii.(A).(3) Borrower Minimum Decision Credit Score."  FHA Single Family Housing Policy Handbook 4000.1.  Federal Housing Administration, January 2 2020.  Web.

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