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Home Loans For People with Bad Credit

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

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

That said, it’s not impossible to get a home loan if you have less-than-optimal credit. There are numerous 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.

We’ll cover:

What is considered bad credit for a mortgage?

Before you apply for a mortgage, it’s good to know how lenders look at your credit scores and your overall credit picture. “Bad credit” in mortgage lending usually means having a score near the minimum allowed for approval, or having a major public record on your credit like a foreclosure or bankruptcy.

There are several different government or government-sponsored agencies that provide guidelines for lenders to follow, including the Federal Housing Administration, Veterans Administration, U.S. Department of Agriculture, Fannie Mae and Freddie Mac. All of them have minimum credit score requirements, but there are other factors beyond your score that could be considered “bad credit.”

This includes significant credit issues like going through a foreclosure, having a judgment for an unpaid student loan or property taxes or bankruptcies. Even if your credit score meets the FICO score requirement, you may have to wait get a new mortgage until a certain amount of time has passed since a major credit event.

The chart below provides an overview of the minimum credit score and how long you’ll need to wait if you’ve had one of the major derogatory events listed.

Minimum Credit Required for Bad Credit Mortgage Loans
Program Type Minimum Credit Score Waiting period for major credit items
FHA loans 500 Chapter 7 Bankruptcy:       2 years from discharge

Chapter 13 bankruptcy:     12 months on time payment on plan

Foreclosure:                        3 years from trustee’s sale

Judgments and tax liens:   OK with payment plan and proof of three payments

Fannie Mae Home Ready 620 Chapter 7 bankruptcy:         4 years from discharge

Chapter 13 bankruptcy:       2 years from discharge

Foreclosure:                         7 years from trustee’s sale date

Judgments and tax liens:    Must be paid in full

Freddie Mac Home Possible 660 Same as Fannie Mae
USDA loans 581 Chapter 7 bankruptcy:        3 years years from discharge

Chapter 13 bankruptcy:      12 months payments made on plan

Foreclosure:                         3 years from trustee’s sale date

Judgments and tax liens:    OK with payment plan and proof of three payments

VA loans None, but individual lenders may have a minimum Chapter 7 bankruptcy:         2 years from discharge

Chapter 13 bankruptcy:      12 months on-time payments on plan

Foreclosure:                          2 years from trustee’s sale date

Judgments and tax liens:    Must be paid in full

 

FHA loans

FHA loans can be solid options for people with low credit scores because they have some of the most lenient qualifying requirements. The FHA will accept credit scores as low as 500 with a down payment of 10% or more. You will need a 580 score to make the minimum down payment of 3.5%.

FHA loans also provide shorter waiting periods than conventional loan programs offered by Fannie Mae and Freddie Mac, after major credit issues like foreclosures and bankruptcies. Borrowers with judgments or tax liens will be able to qualify if they can provide proof of a written payment plan and canceled checks or a bank statement showing they’ve made the first three payments on time.

VA loans

VA loans are a great option for eligible active duty or retired military veterans. There’s no down payment requirement, no official minimum credit score requirement and no mortgage insurance premium.

Although there is no minimum FICO score, lenders offering VA loans often use 620 as a benchmark. The bankruptcy and foreclosure waiting periods are the shortest of all the loan programs offered, allowing a VA borrower to apply for a new mortgage only two years after a bankruptcy discharge or foreclosure sale.

USDA loans

USDA loans are designed to help low-income buyers purchase homes in mostly rural areas. Although the official credit minimum is 640, the USDA provides exceptions for scores as low as 581.

USDA loans follow the same guidelines as FHA loans for the length of time needed after a major credit event to apply for a new loan with the exception of bankruptcies, which require a three year wait.

Fannie Mae HomeReady program

The Fannie Mae HomeReady program allows for a down payment as low as 3% with a minimum credit score of 620. However, a low credit score on a Fannie Mae loan may cost you much more than it will with other loan programs.

That’s because if you put less than 20% down, you are required to have something called private mortgage insurance. This is an insurance premium you pay as part of your monthly payment that protects your lender from losses if you default on your loan — and the lower your credit score, the higher your PMI will be.

Another drawback to Fannie Mae loans is you have to wait much longer if you have a foreclosure or bankruptcy in your credit history.

Freddie Mac Home Possible program

Freddie Mac requires a minimum credit score of 660 for mortgages in its Home Possible program. Freddie Mac loans follow the same credit guidelines as Fannie Mae for foreclosures and bankruptcies.

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 Jason Larkins, a loan officer with United Fidelity Funding Corp. in Scarborough, Maine. “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 small 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 to gift you money toward your down payment.

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 reviews the details of your current financial situation and offers 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 by using HUD’s online search tool or via the Consumer Financial Protection Bureau.

Take a close look at credit reports and dispute charges

Credit bureaus compile information about the credit habits of millions of people, and sometimes inaccurate information can show up 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.

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 calculated by dividing your total debt including your house payment, 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. Another is to increase your income. Either method will improve your DTI.

Focus on a track record of on-time payments

“Automated underwriting systems really frown upon recent late payments,” Larkins said. 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

When you have bad credit, 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,” Larkins said.

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 of $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, and other charges. 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 have an idea of 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?

The table provided earlier in this article gives you the waiting periods required to get a new mortgage after you’ve claimed a bankruptcy. It’s also important during the waiting period to manage all your other credit on time, and avoid opening too much new credit.

Can I get a home loan after foreclosure?

If you’ve had a foreclosure, you’ll have to wait longer than you would after any other credit issue. It’s important that you know the date of the trustee’s sale before you talk to a loan officer — credit reports often misreport that actual date a property was finally foreclosed, and instead list the date the foreclosure was started.

In some states a foreclosure can take several months, and even years to be completed. If there were extenuating circumstances leading up to the foreclosure, such as illness or job loss affecting the household’s primary earner, there may be exceptions allowing you to get a loan sooner.

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.

Lenders may be willing to approve you for a cash-out refinance even if you have bad credit, if you are using the extra cash to pay off lots of revolving debt that is maxed out. Besides getting rid of your monthly payments, paying off the balances on credit cards could also significantly improve your score.

Can I have a cosigner on a home loan?

Yes, you can have a cosigner on a loan but, 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 puts his or her credit score at risk.

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

Most loan programs allow you to have a late mortgage payment or two and still be approved for a new mortgage. Keep in mind that mortgage lenders are mostly concerned with verifying you’ll be able to repay a new home loan, so your payment history on a current mortgage is definitely taken very seriously.

Will credit collection judgements show up on my credit report?

Depending on the original creditor, there are times when a judgment for a collection won’t show up on your credit report. However, there are judgments that can be attached to your home, and if they are, the lender will discover them when they review the title report.

You may have to pay them off before you can close your loan. Or if you have a written payment plan, FHA, VA and USDA lenders may accept a copy of the payment plan and proof of three on-time payments to approve your loan.

The bottom line

Getting a home loan when you have bad credit may be difficult, but it can be done. You can expect a higher interest rate and monthly payment, but if you have done your research to find out which loan programs are the best suited for you, taken steps to improve your credit as much as possible before applying and are working with a lender who has experience assisting those with less-than-perfect credit, you can still be a successful homeowner.

The information in this article is accurate as of the date of publishing.

 

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