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Home Loans For People with Bad Credit

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Bad credit can happen to anyone. All it may take to damage your credit score is a few missed payments, some accrued debt or even life circumstances beyond your control, such as divorce or serious illness.

Unfortunately, when you have a lower credit score, it can be much harder to get a home loan. You may also be subject to much higher interest rates and fees than someone with better credit would have to bear.

That said, it’s not impossible to get a home loan if you have less-than-optimal credit. There are home loan options available for borrowers with bad credit. We’ve laid them out for you below, along with some tips on how to get your credit in the best shape possible before applying for a mortgage.

Home loan options for borrowers with bad credit

Fortunately, loan options for people with bad credit do exist. We’ve compiled some of them below, along with their qualifying criteria.

Credit Score Required Down Payment Required Mortgage
Insurance
Fees/Fine Print
FHA loans 500-579
580+
10%
3.5%
10% down payment,
11 years of premium payments
> 10% down payment
Over the life of the loan
Upfront MIP:
1.75%
Annual MIP:
0.45% – 1.95%
Fannie Mae HomeReady program 620 3% Yes, until your home equity reaches 20% Subject to certain income limits
Freddie Mac Home Possible program 660 3% Yes, until your home equity reaches 20% No minimum personal funds required
USDA loans 640 0% No Your adjusted income must be at or below 80% of the area’s median income for USDA direct loans. The income limit for USDA-backed loans is limited to 115% of the area’s median income.
VA loans None, but individual lenders may have their own requirements 0% No At least 90 days of continuous service during wartime or 181 days of service during peacetime

FHA loans

FHA loans can be solid options for individuals with low credit because they have some of the most lenient qualifying requirements. The FHA will accept credit scores as low as 580 with a 3.5% down payment, and, if you’re able to bump that down payment up to 10%, borrowers may have a score as low as 500.

Additionally, according to Jason Larkins, a loan officer with United Fidelity Funding Corp. in Scarborough, Maine, the mortgage insurance on FHA loans is not credit-based, meaning having a low score won’t cost you any more. Instead, the mortgage insurance is calculated as a percentage of the overall loan.

VA loans

VA loans are unique in that they have very few official qualifying requirements. There’s no down payment requirement, no official minimum credit score requirement and no mortgage insurance premium. Instead, the lender is required to look over the entire loan profile before making a determination. This gives veterans more financial flexibility. However, in order to be deemed eligible to get a VA loan, veterans must meet specific length-of-service requirements.

USDA loans

USDA loans are uniquely set up to cater to those with credit issues. Although the official credit minimum is 640, the USDA provides a specific set of guidelines for exceptions to that rule. The government program will accept scores as low as 581, provided that the credit issues are due to temporary circumstances beyond your control or reducing your housing expenses will enable you to start paying off your debts.  

Fannie Mae HomeReady program

The Fannie Mae HomeReady program is well-suited for borrowers with poor credit because the minimum credit score is just 620. However, that’s not the only factor loan officers will review when deciding whether to approve you for a loan.

“Any time anyone will look at someone with close to a 620 score, they’ll look at what’s called layering risk,” says Larkins. “This means things like missed payments, a shaky employment history or overdrafts. The lower someone’s credit score is, the more solid these other areas have to be in order to be approved.”

Freddie Mac Home Possible program

Freddie Mac, which generally requires a minimum credit score of 660 for manually underwritten mortgages in its Home Possible program, recently updated its underwriting requirements to work with borrowers who have no credit history. However, those without a credit history must have at least two other payment references that go back at least 12 months. One of those payment references must be a housing payment history, and there must be no late-payment delinquencies of 30 days or more.

Tips for applying for a home loan with bad credit

Luckily, even if you have bad credit, you can still bolster your chances of getting an approval.

Put down a larger down payment

“If you don’t have the best credit, saving for a down payment will go a long way toward getting you an approval,” said Larkins. “It shows the lender that you have the ability to put money toward your loan.”

As for how to save for a down payment, crafting a budget to find ways to cut expenses or picking up a side hustle to generate more income are obvious solutions. Beyond that, seeking the aid of savings apps, such as Digit and Qapital, can help you put money away by transferring negligible amounts of cash into a savings account at regular intervals. Also, if you have loved ones who may be willing and able to help, you can always ask them about the possibility of providing gift money to go toward your down payment.

Explore first-time homebuyer programs

If you’re a first-time homebuyer, the good news is there are many programs out there aimed at helping you become a homeowner. Typically, these programs will offer payment assistance for your down payment, closing costs or mortgage insurance premium.

That said, specific programs often vary by state or local area, so you’ll want to talk to a lender to find out the options available to you.

Talk to a credit counselor

Sometimes the best thing you can do to fix your credit is to talk to an expert. A credit counselor can look at the details of your current financial situation and offer personalized advice on how to improve your score.

However, not all credit counselors are created equal. You’ll want to work with someone who has been approved by the U.S. Department of Housing and Urban Development (HUD). You can find an approved housing counseling agency near you using HUD’s online search tool or via the Consumer Financial Protection Bureau.

Take a close look at credit reports and dispute charges

Unfortunately, mistakes can happen anywhere, even on your credit report. Take the initiative to request a copy of your credit report and look it over for errors. If you find any, you can follow these procedures to submit a dispute and get the error removed from your report. You can also choose to use credit repair services to help with this and other issues.

Pay down debt and lower DTI

One factor lenders look at when deciding whether or not to approve you for a loan is your debt-to-income ratio (DTI). Your DTI is simply the sum of all your recurring monthly debts divided by your gross monthly income. Ideally, when you’re looking to buy a home, you want to shoot for a ratio that’s no greater than 43%.

If you do the calculations and find out that your debt-to-income ratio is higher than it needs to be, don’t worry; there are steps you can take to improve it. One way is to work on paying down your debts as much as possible. Another is to increase your income. Either method should help improve your ratio.

Focus on a track record of on-time payments

“Automated underwriting systems really frown upon recent late payments,” advised Larkins. If you have a history of late payments, you may want to wait at least four or five months before applying for a mortgage to minimize the impact.”

In the meantime, do your best to create a track record of on-time payments by paying your credit card bill on time, every time.

Risks of getting a home loan with bad credit

Unfortunately, when you have bad credit, the reality is you’re seen as a bigger risk in the eyes of lenders. As a result, you’re likely going to pay more for your loan than someone with an excellent score. For the most part, you’ll see the impact of this in the interest rates you’re offered.

“Generally speaking, every lender has break points on credit — about every 20 points — that will determine the adjustment you’ll get on your interest rate,” explained Larkins.

Though it may not seem like much, a fraction of an interest point can often add up to a difference of thousands of dollars worth of payments over the life of the loan.

To further illustrate his point, Larkins provided the following real-time example. It assumes that you’ve taken out a 30-year FHA loan at $225,000 with a 3.5% down payment.

  • 580: 4.75
  • 600: 4.625
  • 620: 4.25
  • 660: 4%

At the interest rate of 4% you would get with a 660 credit score, your monthly payment would be $1,508.53 when you include fees such as PMI, property taxes, etc. Compare that to a payment of $1,606.24 at the 4.75% rate. That’s a difference of nearly $100 per month, $1,200 per year or $36,000 over the life of the loan.

FAQs about home loans with bad credit

Now that you know how bad credit affects your ability to get a mortgage and what loan programs might be best for you, you may have some more specific questions.

Can I buy a home after declaring bankruptcy?

Yes, you can buy a home after declaring bankruptcy, but there may be a bit of a waiting period. The waiting period you’ll face will depend on the type of bankruptcy for which you filed and the type of loan for which you intend to apply. (It ranges between one and four years.) However, even after that waiting period is over, you will likely face higher interest rates than someone with a better credit history.

Can I get a home loan after foreclosure?

There is also a waiting period after a foreclosure. In most cases, unfortunately, it is even longer than the waiting period following a bankruptcy, ranging from two to seven years. However, you may be able to get this time period shortened if there were extenuating circumstances leading up to the foreclosure, such as divorce or an illness affecting the household’s primary earner.

Can I refinance a bad credit home loan?

Yes, you can still refinance your loan if you have bad credit. The question is, does it make sense? Getting a lower interest rate is one of the primary reasons people refinance their mortgages, and bad credit can hinder your access to the lowest rates. Your best bet is to shop around to find the lowest rate offered to you and to work with a lender to improve your credit as much as possible before applying.

Can I have a cosigner on a home loan?

Yes, you can have a cosigner on a loan, and doing so might even grant you access to a lower interest rate. But, remember, asking someone to be your cosigner is a decision not to be taken lightly. This person will be on the hook for your loan if you miss payments, which means his or her credit score is also at risk. Only ask someone to do this if you are confident they are not putting themselves at real risk.

Can I have late mortgage payments and still get a loan?

According to Larkins, it is possible to have late mortgage payments and still get a loan. The FHA will only allow one late payment within a 12-month period. On the other hand, a conventional loan may give you even more flexibility, depending on the loan program.

Will credit collection judgements show up on my credit report?

Larkins clarifies that, while credit collection judgements will not show up on your credit report, they will be present on the title report that will be evaluated before you sell your current home. You’ll need to clear them up before the sale is able to go through.

The bottom line

Getting a home loan when you have bad credit may be difficult, but it can be done. By doing your research to find out which loan programs are the best suited for you, taking steps to improve your credit as much as possible before applying and working with a lender who has experience assisting those with less-than-perfect credit, you can make sure you’re doing all you can to secure the home of your dreams. The options are out there. You just have to do a little legwork to make them work for you.

 

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