Read any article about how to get a home loan and the first thing you’ll see is “check your credit!” As you dig into the home loan process, you’ll find that almost every part of it is connected to your credit score: whether you can even get a loan, the interest rates, the terms, and the kind of insurance you’ll have to add.
If you have bad credit, home loans can be hard to come by, but what constitutes a bad credit score? Most lenders view a FICO score between 670 and 739 as “good,” and scores between 580 and 669 as “fair.” Borrowers in those categories can usually secure a traditional home loan, though borrowers on the lower end may find themselves paying for mortgage insurance. If your score is below 580, you’ll have some challenges acquiring a home loan, and a score below 500 may make it almost impossible. Repairing your credit is something you can usually accomplish, but with negative statements on your credit remaining in place for 7 years, it could be a very long process. What if you’re ready to buy a home now and have the money to do so, but you’re being held back as a result of your credit? There are a number of steps you can take to increase your odds of borrowing to buy a home.
Before You Begin…
In order to get a home loan if your credit isn’t impressive, you’ll need to seek out programs or grants designed to help borrowers with the resources but not the history to take out a loan as you figure out how to buy a house with bad credit. However, you’ll want to be careful as you explore the various options. First, make sure that you take a close look at each program, and wait to actually apply for any until you’ve investigated them all and decided which ones are the best for you. When you start applying for home loans, all the applications within a 30-day period count as one credit inquiry because the credit bureaus know that you’re applying for what will eventually be one loan. If you go beyond that 30-day period, however, multiple inquiries into your credit history can negatively affect your credit rating, and if you’re already struggling to get a loan with your current credit score, you don’t want to push it even lower.
Secondly, as you research and see what the options are, think carefully about whether you actually want to take advantage of the options available to you. Especially if your negative credit is older, you may be able to get better rates and terms simply by waiting another year or two to bring up your credit score before you buy. Some loans that are aimed at lower-credit buyers are legitimate and will carefully assess your financial situation to make sure you’re not taking out a loan you can’t pay back. Other programs offer bad credit mortgage loans, or what are known as subprime mortgages. These are mortgages for which you’ll pay an exorbitantly high interest rate or only be offered an adjustable-rate mortgage, where the payments will be manageable for a few years, and then the rate will jump higher and you’ll suddenly have to pay much more each month. These loans lure borrowers in with a sense that they can get into a house and either find a way to manage once the rate hike happens or refinance out, but if you’re unable to do that, you can lose your home and further damage your credit. Choose carefully, and make sure you can really afford to make the payments you’re committing to before closing on any loan.
Tips for Getting a Home Loan With Bad Credit
- Access your credit reports from all three agencies to check for errors
- Take the time to speak with agents for several lenders
- Be patient. It’s going to take a little more effort and time than it would if your credit was excellent, but it will likely pay off in the end.
STEP 1: There are some loans with lower credit score minimums to consider, such as an FHA loan, VA loan, USDA loan, and more.
Several programs guaranteed by the federal and state governments are legitimate sources of information about home loans for bad credit. Before these programs existed, homeownership was a privilege only afforded to those who had savings for a substantial down payment, significant income, and excellent credit. Buyers who were missing any of those pieces were regarded by lenders as too risky: Low down payments meant lenders would lose money if they had to foreclose and sell a home, lower income reduced the chances that a borrower would be able to make consistent monthly payments, and a checkered credit history suggested that the borrower had had problems paying their debts in the past. Some lenders did offer loans to less-than-ideal borrowers, but few lenders that offer bad credit mortgage loans guaranteed approval, so applying would damage the buyer’s credit with little hope of success. These standards were preventing quite a few buyers who were capable of making payments from taking out loans. Homeownership adds stability to the economy, so several government agencies, including the Federal Housing Administration (FHA), the United States Department of Veterans Affairs (VA), the United States Department of Agriculture (USDA), and a number of state and local agencies saw the opportunity to get more people into homes by securing their loans, reducing the risk to lenders.
FHA loans allow buyers with smaller down payments or lower credit scores to qualify for home loans. The FHA saw a contingent of buyers who were fully able to make payments, but due to high rent and sometimes lower income, had been unable to save up a large enough down payment and had possibly struggled to make ends meet in the past. Lenders saw these buyers as too risky, so the FHA developed its own loan program. It guarantees the loans, so if a borrower defaults on their mortgage, the FHA will cover the funds lost by the lender, making it safer for lenders to extend loans to borrowers with bad credit and lower down payments. The parameters are specific: For buyers with credit scores of 580 or higher, the minimum down payment is only 3.5 percent, but buyers with scores as low as 500 can get a loan if they can scrape together a 10 percent down payment. Scores below 500 will not be able to qualify for this program. FHA loans do include mortgage insurance payments each month that cannot be canceled until the loan is paid off or refinanced, so some of your monthly payment will go toward that insurance instead of your loan balance.
Service members in all the branches of the United States military face special challenges when it comes to home buying. Long deployments, sudden reassignments, and the comparably lower pay scale for enlisted members can mean frequent (and sudden) moves. Service members and their families may struggle with down payments, especially if they find themselves in a situation where they’re trying to sell a home in one location when they’ve been suddenly transferred to another—so they’re still paying a mortgage on a home they no longer live in. And while some veterans make the transition to civilian life easily, it’s not always a smooth or swift path, which can lead to financial instability. The VA offers a home loan program to veterans, active service members, and the surviving spouses of service members that helps make home buying easier. Similar to the FHA program, the VA guarantees a part of the loan, making it less risky for lenders to approve mortgages for eligible members even if their credit scores are low. It’s possible to get a VA loan even if you have a bankruptcy on your credit report, and often you can get a VA loan with no down payment at all.
The USDA loan program has two objectives: helping lower-income buyers get into homes sooner and repopulating rural areas to increase productivity and economic stability in those areas. The parameters for these loans are quite specific: The home must be in a designated rural area, and the buyers must meet income parameters that vary by location. There are two types of USDA loans: The first is achieved through USDA-approved lenders, in which the USDA guarantees the load to offset the lender’s risk, and the other is acquired directly from the USDA. Buyers with credit scores of at least 640 can get a loan through a lender, but there is no minimum credit score required for a loan taken directly from the USDA and no down payment required for either type.
Two other programs operate a bit differently: Fannie Mae’s HomeReady loan program and Freddie Mac’s Home Possible loans are disbursed directly from Fannie Mae and Freddie
Mac, rather than being issued through other lenders and guarantees. HomeReady is aimed at borrowers without credit scores—those who haven’t taken loans or used credit significantly enough or for long enough to generate a credit score. Borrowers who don’t have standard paperwork documenting income and assets can also take advantage of this program, such as independent contractors or freelancers. Borrowers in this program can use other sources to demonstrate their ability to make timely payments, such as stubs from utility and bill payments and bank statements. This program only requires a 3 percent down payment, but down payments lower than 20 percent will require private mortgage insurance. Home Possible loans are also focused on buyers without credit histories, but they require a 5 percent down payment and also require private mortgage insurance for down payments less than 20 percent.
STEP 2: Boost your approval chances by increasing your down payment, decreasing your debt and DTI, and more.
If your credit score is the only significant negative in your loan application package, lenders are more likely to see it as just one component of your financial package and will look to your other strengths to balance it out. If, however, the rest of your application also has numbers that skate close to the line, you’ll look like a much bigger risk. Your credit will take the longest to improve, so while you continue to focus on that, you can take immediate steps to bolster the rest of your package.
First, work hard to build your down payment because higher down payments signal lower risk to lenders—the more of your home you have paid for outright, the less they stand to lose if you default. In addition, a higher down payment reduces the likelihood that you’ll have to pay private mortgage insurance or mortgage insurance premiums, so more of each monthly payment will go toward paying down your debt instead of insuring your loan.
DTI, or debt-to-income ratio, is the balance between your income each month (before taxes) and the amount you must pay toward debt. Lenders use this as an indicator that you’re not taking on more debt than you can afford to pay. It’s key to understand that this ratio only includes monthly payments toward debt; it does not include utilities, insurance, food and clothing expenses, entertainment, gas, or any of your other cash flows. While each mortgage lender and program will stipulate its maximum DTI, it’s not really a number you want to max out if you want to be able to comfortably pay your bills. Paying down existing debt as quickly as you can will reduce this ratio and increase your chances of getting a loan—and make you more comfortable paying it.
One other option to support your application and take the onus off of credit problems is to find a cosigner. Cosigners sign the paperwork for the mortgage with you, and in doing so, agree to pay the debt should you be unable to do so, which can make the difference when buying a house with bad credit. It’s a huge risk for the cosigner, who is then also carrying your mortgage on their own credit report and increasing their own DTI. Usually cosigners are close family members who have faith in your intention to pay the loan and who may be comfortable with carrying you over a rough patch or two—but who can count on you to take care of your business.
STEP 3: Understand what’s on your credit report and take steps to repair your credit.
Credit scores are somewhat mysterious; few people really understand how they are calculated, as the actual math that goes into determining a FICO credit score is a closely guarded secret. However, there are several factors that have clear effects on your score, and you can take steps to improve those factors. Before worrying about how to adjust your score, you’ll need to take a solid look at your credit history. Get copies of your credit report from all three major credit bureaus (Experian, Equifax, and TransUnion). Sometimes creditors report to one of the agencies and not the others, so you’ll want to check all three. You’re entitled to one free credit report each year from each agency through the Federal Trade Commission’s website—be careful about signing up for other “free” credit report sites that promise your report and score for a fee. Check your report carefully, looking for errors and ensuring that all the accounts on the report are accounts that you recognize. Any problems can be disputed with the credit bureaus, but that can take some time, so start early.
What goes into a credit score? Your payment history makes up about 35 percent of your overall score, and a clear, lengthy record of on-time payments goes a long way toward showing lenders that you take debt payment seriously. If this is something you’ve struggled with, you’ll want to put an extra effort into making those payments on time before you apply for a mortgage—assuming that your payments have been late because you’re forgetful or just don’t get payments in the mail on time. In those cases, consider taking advantage of your bank’s payment scheduling function or autodraw options offered by your creditors and utilities to ensure payments get in on time. If, however, your payments are frequently late because you’re struggling financially, it’s probably a bigger priority to become more financially stable before you apply for a loan.
Credit utilization, or the amount of credit that you have available balanced against the amount of credit you have used, makes up another 30 percent of your credit score. Borrowers who have a significant amount of credit available to them that they have not used show that they’ve qualified for credit to be extended to them but don’t need to use it all, and they will have higher credit scores as a result. If, on the other hand, your credit cards are all close to maxed out, or you have additional personal loans that are early in repayment, it appears to lenders that you’re dependent on credit to remain financially solvent, which will lower your credit score and cause lenders to avoid increasing your overall debt, as they’ll doubt your ability to pay. To improve your credit score, work on paying down existing credit card debt so that the ratio between available and used credit is healthier. If you are a customer in good standing, and you’re not already overextended, you can ask your credit card companies to increase your existing limit, which will shift the balance in a positive way.
Several other components, such as the age of your credit history and the mix of existing credit, are things you can’t do much about. You can’t jump back in time and take out your first credit card or car loan sooner, so really your only move on the average age of credit is to avoid closing your oldest accounts, even if you don’t use them, and avoid opening a lot of new accounts shortly before applying for a loan. First, if you have bad credit, credit card approval may be difficult to find, but also adding new accounts will skew the average age of your credit. The mix of your existing credit involves the combination of different types of credit you have on file: credit cards, car loans, student loans, and other types of debt. The greater the mix, the higher your score. If you’re still some distance away from applying for your home loan, you may be able to affect this mix by paying off and closing some accounts.
Accounts that are in collection are the biggest negative that you can have on a credit report, because they suggest (not always accurately, but they do suggest) that you have not made an attempt to pay back the debt or have abandoned it. There are some options, once an account in collections is paid off, that will allow you to pay an extra fee to have the collection removed from your account. If you choose to do this, you’ll want to take care to get confirmation of the deletion in writing and to check your credit report a month or two later to make sure the negative item has been removed from your credit history.
STEP 4: Look for grants.
Most of the agencies that back home loans for low-income or poor-credit buyers are part of the federal government or are federal contractors. State and local programs don’t generally have the resources to take on that kind of risk. What you will find in state and local programs are assistance programs to help with down payments. A larger down payment makes borrowers with poor credit much less risky for the lender, so increasing your down payment through a grant or down payment assistance program can significantly impact your overall application and make your poor credit weigh less on your options. Some of these programs are income-dependent, while others are designed to help recent college graduates afford a down payment, and there are many other specific programs based on where you live. Contact local government housing agencies or work with a mortgage lending professional to learn more about programs available to you.
STEP 5: Take the time to find the right lender.
This is an incredibly important step when your credit score is less than optimal and you’re seeking home loans with bad credit. While federal programs have specific parameters that their approved lenders must meet, there’s no rule that every lender has to participate in those programs. You may need to call quite a few lenders to inquire about programs available for buyers with poor credit. Because there are so many different loan programs available, some lenders may not participate, or, somewhat shockingly, may not be aware that certain programs even exist. If you’re a buyer with a strong application package other than your credit score, you’ll need to advocate for yourself and seek out cooperative lenders who know what they have available and are willing to explain it to you clearly. If you contact a lender who won’t explain your options clearly or gives you a hard time, it’s probably not the right lender for you. The right lender will be open to explaining their programs, explaining how your profile fits each one, and discussing the terms and implications openly. Ideally, you’ll identify several lenders with whom you’re comfortable, and then you can place applications with them to compare the terms and rates that you’re offered.
STEP 6: Consider other options, such as taking out a personal loan or simply waiting before taking out a mortgage.
It can feel very unfair to be rejected for house loans for bad credit, especially if you’ve put significant effort into improving yours. The fact is that credit takes time to improve as the negative items age out and are replaced by a cleaner slate. If you’re unable to get a home loan, you can consider applying for a personal loan, which has different criteria that you may be more able to meet. But be careful: The terms on personal loans may be shorter, and the interest rates higher.
If you find that your applications for home loans are repeatedly unsuccessful, it may be time to adjust your plans. Those rejections suggest that lenders are too uncomfortable with your financial situation to loan you money, and that’s an important piece of information for you to have. Lenders are businesses, certainly, and operate to make money, but they’re also not in the business of destroying people financially if they can avoid it. They don’t want you to default. If several lenders think you can’t manage a home loan right now, you should consider why. Defaults on home loans may make it impossible to get another one for years and often result in bankruptcy. So if you’re struggling to get a home loan, consider taking some time to repair your credit, build savings toward a solid down payment, rebalance your DTI, and try again in a year or two when your financial health is on more solid ground.
Is it possible to get a home loan with bad credit? If the rest of your financial profile is healthy, then it absolutely is, especially if you apply through one of the programs designed to help. As always, you’ll want to look at your overall financial situation, and remember that just because you can take a loan doesn’t mean that you should. Discussing your application with a mortgage professional can go a long way toward helping you make the best choice for you and get you into a home you love at the right time.