Can I Get a Conventional Loan if I Have Bad Credit?

You may have heard that getting a conventional loan with bad credit is impossible, but that isn't the case. Much more goes into mortgage decisions than just your credit score.

Even with less-than-perfect credit, qualifying for a conventional loan is possible. And if you don’t qualify, there are plenty of alternatives for buyers who don't meet the conventional loan minimum credit requirement.

Highlights:

• You can still qualify for a conventional loan with bad credit, but your credit score impacts factors like your interest rate and loan terms.
• The minimum credit score for conventional loans is 620, but recent changes allow lenders to average co-borrowers’ scores.
• Alternatives like FHA, VA, and USDA loans offer more flexibility for borrowers with low credit scores.
• Improving your credit score can help you secure better interest rates and lower your monthly payments.
• Applying for a conventional loan is the best way to see your true mortgage credit score and explore all available options.

Conventional Loan Minimum Credit Score

Conventional loans, also referred to as conforming loans, are a type of loan that meets the guidelines put forward by Fannie Mae or Freddie Mac. These government-sponsored enterprises (GSEs) play an essential role in the mortgage market, and most lenders follow their standards for vetting borrowers.

For a conventional loan, the minimum credit score is 620. However, there is an exception to this rule that we’ll explain as soon as we cover how lenders determine your credit score.

Lenders typically establish your credit score by pulling reports from the three major credit bureaus.

The official figures they use are the following:

• Experian/Fair Isaac Risk Model V2SM (FICO Score 2)
• TransUnion FICO Risk Score, Classic 04 (FICO Score 4)
• Equifax Beacon 5.0 (FICO Score 5)

Unfortunately for borrowers, getting an accurate credit score can be difficult because free credit reporting websites often show different numbers than lenders use. In fact, you may encounter more than a dozen different types of FICO scores!

This lack of transparency within the credit reporting industry causes serious confusion among consumers.

Applying for a conventional loan is the best way to get your true score. Your mortgage broker or loan officer has access to the true mortgage credit scoring models mentioned above. They can also guide you through improving your chances of qualifying.

Use a Co-Borrower’s Score To Gain Conventional Loan Eligibility

With most loan types, lenders judge joint mortgage applicants on the credit score of the lowest-scoring borrower. Historically, this has even been true for conventional loans. But thanks to recent guideline changes from Fannie Mae, conventional lenders may now use the average of the borrowers' scores.

For example, if your FICO score is 600 and your co-borrower’s score is 700, lenders will use the average of 650 to determine eligibility. In this case, the 600-credit-score borrower would be eligible for a conventional loan, thanks to their co-borrower.

Lenders won’t use the average score to determine your rate. And you still might not qualify for the loan. The rate average simply lets you be considered for a conventional loan.

However, Fannie Mae's new guidelines also come in handy for borrowers with good credit but insufficient income (or too much debt) to qualify for a mortgage. They can now apply jointly with a bad-credit co-borrower and count both incomes in calculations.

Conventional Loan Alternatives if You Don’t Meet Credit Requirements

Although conforming loans comprise the lion's share of mortgages, several conventional loan alternatives can be better suited for borrowers who don't meet traditional credit requirements:

FHA

Secured by the Federal Housing Administration, FHA loans require a minimum credit score of 580 with a 3.5% down payment. Getting an FHA loan with a credit score as low as 500 is possible, but you should plan to put at least 10% down.

VA

VA loans are backed by the Department of Veterans Affairs and are available with 0% down to veterans, current service members, and some military spouses. There's no fixed minimum credit score, and each lender sets its own credit standards.

USDA

Ideal for bad credit borrowers planning to purchase outside of an urban area, USDA loans require 0% down and have no guidelines on a minimum credit score. Lender-specific credit minimums can range from 580-640. It's worth noting that income restrictions can disqualify high-earning applicants.

Improving Your Credit To Get Up to the Conventional Loan Standards

If your credit score isn't quite up to conventional loan standards, or if you want to bump up your score to reduce interest rates and closing costs, don't worry. There are some steps you can take to improve your credit profile in a relatively short time:

1. Comb through your credit reports (get them for free from AnnualCreditReport.com) and look for any errors. You can remove inaccurate entries by disputing the information. You can also hire a credit repair company to help with the process.
2. Avoid missing any payments between now and when you plan to apply for a conventional loan. Missed (and late) payments have the most significant impact on your credit score.
3. Pay down credit cards and other types of revolving debt. Lenders like to see your credit utilization below 30%. If your utilization rate is currently high, paying it down will likely be the quickest way to see a change in your score.
4. Don’t cancel credit cards or close accounts once you pay them off. Your credit history's age plays a role in your credit score, and leaving older accounts with a zero balance is far more beneficial than closing them out.

If you’ve had any significant derogatory credit events, like bankruptcy or foreclosure, you’ll need to wait a set amount of time before you can easily qualify for a loan. Here's a convenient chart explaining how long each typical credit event will impact your loan chances:

Even if you already meet the minimum credit requirements to get a conventional loan, raising your credit score can qualify you for more favorable interest rates. Better rates will save you money each month that can add up over the life of your loan.

Here’s an example of what you might pay for a $300,000 loan based on your credit score.

*Example rates from MyFico.com loan savings calculator, accessed 7/29/23. Interest rates are for example purposes only. Not a quote or commitment to lend. Rates may not be available.

As you can see from the chart, even a slight improvement to your credit score can significantly affect your mortgage costs.

Apply for a Conventional Loan To See if You Qualify

Although free credit reporting websites can give you a reasonable credit score estimate, the most accurate way to determine if you qualify for a conventional loan is to apply.

Plus, lending professionals have access to many different mortgage products. So even if you aren't eligible for a conventional loan, they can point you toward the best alternatives that fit your unique situation.