According to VA guidelines, veterans with poor credit scores, such as 500, can still be approved for VA loans. That said, all mortgage lenders must ensure that a borrower meets the minimum Veterans Administration requirements to approve VA loans. In addition to that, lenders can set requirements above the VA minimum prerequisites called lender overlays that may have different credit score requirements.
To many lenders, lower credit scores are a reflection of a borrower’s financial trustworthiness. According to Experian, a score ranging between 300 and 579 is considered “Poor.” Most lenders are more hesitant to issue loans to people with bad credit, as low scores indicate the consumer may have missed multiple bill payments or previously underwent a foreclosure.
Although the U.S. Department of Veterans Affairs (VA) does not set a credit score minimum, can someone with a 500 credit score qualify for VA loans? This depends on many factors, such as what lender overlays are in place, what the causes of the poor credit were, and if the borrower can reasonably afford the mortgage loan amount. Keep reading to learn what options are available to those with bad credit and how to best qualify for a VA loan.
How does a VA-backed home loan work?
VA loans are mortgage loans guaranteed by the U.S. Department of Veterans Affairs for use in the United States. These loans are available to eligible American veterans or their surviving spouses (provided they do not remarry).
The VA stands behind or backs a portion of the loan you get from a private lender. If your VA-backed home loan goes into foreclosure, the guarantee enables the lenders to recoup some or all of their losses. Since there is less risk to lenders due to the guarantee, you’re more likely to receive better loan terms, such as lower interest rates. This also helps to approve loans to borrowers despite having bad credit.
Baseline VA underwriting criteria for loan approval
When looking for a VA loan, remember that the below measures are put in place regardless of the applicant’s credit score.
- No maximum debt ratio. However, a lender must provide compensating factors if a borrower’s total debt ratio is more than 41%.
- No maximum loan amount.
- VA’s residual income guidelines ensure that borrowers can afford the loan. These guidelines determine how much money must be left over after debts and living expenses are considered.
- No minimum credit score requirement. The VA requires a lender to review the entire loan profile, rather than credit score figures.
Is there a minimum credit score for VA loans?
Although credit score minimums are determined for conforming, conventional, and Federal Housing Administration (FHA) loans — what about VA loans? Can you be approved for a VA loan with a 500 credit score? The short answer is yes, it is possible. The U.S. Department of Veterans Affairs sets no credit score minimum for VA loan eligibility. (Source)
That said, there’s no one-score-fits-all when applying for VA loans, and qualifying veterans can still be denied because of bad credit. (Source) Each Ginnie Mae-approved issuer (VA-approved lenders) must decide if a specific credit profile is too risky to approve for a VA loan.
VA-approved lenders can have varying credit score requirements. If one lender says you don’t qualify, this doesn’t mean other lenders can’t approve you. However, keep in mind that it may take some digging to find a lender willing to work with your credit profile. To get a better idea of this, take a look at some of the offers below, all of which are VA-backed home loans.
What can affect VA-loan approvals?
Even though the Department of Veterans Affairs doesn’t have any credit score requirements, there are a few other systems in place that can affect your chances of approval with a 500 credit score. The two biggest potential reasons are automated underwriting systems and lender overlays.
Automated underwriting systems
Automated underwriting systems (AUS) are intricate and sophisticated computer programs that analyze information about a borrower’s credit score, payment history, public records, assets, income, and liabilities. It provides an automated decision on whether the loan should be approved or needs to be manually reviewed.
Whether the loan is FHA, VA, USDA, or conventional, lenders are required to submit a mortgage application through its perspective AUS. The system will then provide one of two responses: refer/eligible or approve/eligible. If the response is “refer/eligible,” the application must be manually underwritten to approve the loan.
Freddie Mac’s Loan Product Advisor, Fannie Mae’s Desktop Underwriter, and VA-approved proprietary lender AUS systems are each approved for use when determining borrower risk for a VA loan. Granted, neither Freddie Mac nor Fannie Mae approves or disapproves VA loans, but these automatic underwriting systems indicate a risk classification.
You may be asking yourself, “Why does this matter?” Because of current government guidelines, if a lender uses the Freddie Mac or Fannie Mae AUS system, the minimum credit score to automatically approve loans is 620. Since not all lenders are willing to put the extra effort in to manually underwrite a loan, you may need to do some digging first.
What is manual underwriting?
Manual underwriting is when an actual person (known as the underwriter) analyzes your finances and finalizes a decision on whether you qualify for a mortgage. This process requires more paperwork than automated underwriting, and thus takes more time.
Your underwriter will ask for copies of documents like tax returns and bank statements. They will examine records such as your credit report, income, assets, debt, and liabilities before approving or denying the loan.
Federal guidelines dictate minimum requirements for borrowers to qualify for home loans. However, lenders are allowed to add additional requirements above the government guidelines.
These stricter policies are called lender overlays, or mortgage overlays. Lenders set these additional requirements as a buffer to decrease the likelihood of borrowers defaulting on their home loans.
So if you have a 500 credit score, you’ll need to shop around for a mortgage lender that doesn’t add lender overlays to VA loan requirements, or one that’s willing to manually underwrite a loan for borrowers with bad credit.
Additional qualifying factors to apply for a VA loan with bad credit
Veteran homebuyers with low credit scores should work with lenders to create a financial plan of action. Although there are no VA-set minimum credit score requirements, depending on the AUS used or lender overlays, a lender may require additional details explaining the reasons that caused a credit score lower than 620.
Based on the information, a lender will then decide if the reason qualifies as “satisfactory credit” or not. Then, depending on that answer, the lender will determine whether to approve the loan.
Reasons counted as “satisfactory credit”
Part of the reason why the VA does not set a minimum credit score is that there are varying factors why someone can have poor credit. For example, if you haven’t been in the country, and you don’t have much of a credit history, a poor credit score doesn’t directly reflect financial irresponsibility. The VA has thus put fairly lenient qualifications in place.
Despite a poor credit score, if the following fits your situation, the VA will still view you as having “satisfactory credit.”
The way a borrower handles debt will make or break approval for VA loans. Your most recent 24-month rental history will be examined, along with any outstanding, assumed, or recently retired mortgages.
Lenders will look for mostly on-time housing payments, as these payments show financial responsibility and trustworthiness. Even if you’ve made timely payments on bills and obligations over the past 12 months consecutively, the VA views you as having satisfactory credit.
Lack of credit history
The VA realizes that some borrowers routinely used cash rather than credit and have not yet developed a credit history. This will not result in the VA declining a loan request if the borrower can show proof of timely rental or housing payment history.
Isolated collections accounts
Isolated instances of unpaid collection accounts do not need to be paid off as a condition for loan approval. A credit report may show several satisfactory accounts but one or two unpaid medical (or other) collections.
Although it is preferable to have all collections paid, the VA does not view this as a requirement for loan approval.
Bankruptcy claimed more than 12 months in the past
Even if bankruptcy exists on a borrower’s credit history, this does not in itself disqualify someone from being approved for a VA loan. Sufficient credit is generally considered re-established after the borrower has made timely payments on debt or housing for 12 consecutive months.
Bankruptcy claimed within the past 12 months
If you meet both of the following two criteria, your lender could overlook the bankruptcy and deem you as having satisfactory credit.
- Obtain consumer items on credit since claiming bankruptcy and make timely payments.
- Prove that the bankruptcy was caused by circumstances beyond your control. Circumstances such as unemployment, prolonged strikes, and medical bills not being covered by insurance could qualify you.
Bankruptcy petition under chapter 13 of the bankruptcy code
This type of filing shows an effort to pay creditors. Generally, regular payments are made to a court-appointed trustee over a period of two to five years. If you finished making all payments satisfactorily, the lender may conclude you’ve re-established satisfactory credit.
Even if payments remain, but 12 months of timely payments have been made and the Trustee or the Bankruptcy Judge approves the new credit, the lender may view this as satisfactory credit.
Reasons considered “unsatisfactory credit”
The following situations are viewed by the VA as a substantial financial risk to lenders and would result in unsatisfactory credit.
- Late or unpaid debts. Unpaid debts, or ones that weren’t paid on a timely basis, result in unsatisfactory credit. This will likely result in the loan being declined even if an unpaid debt is paid at a later date. To be approved for a VA loan with satisfactory credit, you must have a period of submitting timely payments on subsequent obligations for at least 12 months.
- Outstanding debts are judged by a court. Unsatisfactory credit results when account balances are reduced to judgment by a court. To re-establish sufficient credit, these balances must either be paid in full or through a repayment plan. If the judge chooses a repayment plan, you must build a history of timely payments for 12 consecutive months to reestablish satisfactory credit.
- Bankruptcy. If you claimed bankruptcy within the past 12 months, and your circumstances do not fit the above-mentioned clauses regarding bankruptcy, the VA deems you as having unsatisfactory credit.
What to do if your application is rejected?
If you are an eligible service member and your VA loan application is rejected, your lender is required to provide you with an adverse action notice. This notice outlines financial deficits that caused the application to be declined.
This tool can help create a plan of action to reverse credit deficiencies. There are some cases where credit fraud is uncovered. Disputing the accuracy or completeness of the fraudulent records could be the step required to qualify for the loan.
If you need some help analyzing your credit report for errors, you may want to consider contacting a credit repair company.
How to increase your loan application approval success
The biggest factor in getting approved for a VA loan involves on-time payment history. If you’ve made timely payments over the past 12 months on obligations, bills, and housing, your odds of approval for a VA loan are much higher. This is even despite having a poor credit score.
That being said, there are some other factors that could further increase your approval success.
- Show cash flow. For banks, a combination of sufficient income and a significant down payment can offset the risks associated with bad credit.
- Reduce your debt-to-income ratio (DTI). DTI is an indicator that most lenders use to measure a borrower’s ability to make monthly payments. Aim for a DTI of 41% or lower to increase your chances of being approved.
- Larger down payment. The larger the down payment, the less risk to lenders, and the VA already covers your down payment. However, if the house cost is above the loan limit for your county and you don’t have full entitlement, a larger down payment may be required to reduce the loan-to-value (LTV) ratio.
- Increase your credit score. This will be the most direct method to result in an approved VA loan. Pay off unsettled obligations and make on-time payments on debts over a period of time. You may also want to request a credit report that outlines a recovery action plan.
- Add a co-signer. Co-signers can be of assistance if they have better creditworthiness and would qualify for the new loan. Co-signers with good credit give lenders assurance that the mortgage loan will be repaid by someone if the primary borrower defaults.
Fortunately, there are several VA-backed loan options that accept co-signers, which you can compare below.
What FICO score is used for a VA loan?
A lender must pull a credit check using either tri-merged credit reports (MCR) or residential mortgage credit reports (RMCR) to conform to VA loan standards. MCR is a combined score of all three credit bureaus (TransUnion, Experian, and Equifax), which is the same as your FICO score.
What are VA home loan limits?
VA loan limits reflect conforming loan limits for Fannie Mae and Freddie Mac single-unit loans. Each veteran has a guarantee entitlement. The guarantee is a minimum of $36,000 and a maximum of 25% of the county loan limit. VA does not set the maximum amount an eligible veteran may borrow. To purchase a property that is over the county loan limit, borrowers may need to combine their entitlement with a down payment to reach a better loan-to-value ratio.
Unlike Fannie Mae and Freddie Mac, the VA does not purchase and securitize loans. Instead, VA loans are most often guaranteed through Ginnie Mae’s mortgage-backed securities.
- Bad credit is not the determining factor if a VA loan will be approved since there is no minimum credit score to qualify.
- Due to lender overlays, a financial institution may not approve VA loans to qualifying service members with bad credit.
- Shop around for a lender willing to work with borrowers with low credit scores and ready to manually underwrite the loan as necessary.
- According to VA guidelines, timely payments on obligations and debts over the past 12 months are integral factors for VA loan approval, rather than bad credit scores.
View Article Sources
- Selling Guide — Fannie Mae
- What is a debt-to-income ratio? — Consumer Financial Protection Bureau
- VA Home Loan Types — U.S. Department of Veterans Affairs
- What is a VA Loan? A Comprehensive Guide — SuperMoney
- How Many Times Can You Use a VA Loan? — SuperMoney
- How to Improve Your Credit Score — SuperMoney
- 3 Reasons Why You Should Make a Down Payment on Your VA Loan — SuperMoney
- VA vs. FHA vs. Conventional Loans — SuperMoney
- Quicken Loans vs. loanDepot vs. Veterans United: How Do These Mortgage Lenders Compare? — SuperMoney
- What Is the Average Credit Score After a Chapter 13 Discharge? — SuperMoney
- Best Credit Repair Companies — SuperMoney
- Veterans United Home Loans Mortgage — SuperMoney
- Veterans United Home Loans — SuperMoney