How To Get A Mortgage When You Have Bad Credit

A low credit score isn't always a deal breaker.
The credit score you need to get a mortgage might be lower than you think.
sturti via Getty Images
The credit score you need to get a mortgage might be lower than you think.

Bad things happen to good people, and bad credit is sometimes one of them. It can be a pain: A poor credit score makes it tougher to get approved for credit cards and loans. And when you are approved, the interest rates are sky high.

So for those of you with bad credit, it’s no surprise if you’ve written off becoming a homeowner. But don’t give up just yet. It is possible to get a mortgage with bad credit.

What Is Considered Bad Credit When Buying A House?

Bad credit” can mean different things depending on whom you ask. That’s because you actually have dozens of credit scores, all of which vary depending on the credit bureau and scoring model. However, your FICO score is what’s used by 90 percent of lenders when making decisions.

According to credit reporting agency Experian, this is how FICO credit scores break down:

  • 800 or higher: Exceptional

  • 740-799: Very good

  • 670-739: Good

  • 580-669: Fair

  • 579 or lower: Very poor

Experian notes that those who fall into the “fair” range are considered to be subprime borrowers. That means they represent a higher risk to lenders and, in general, are going to be subject to higher interest rates and fees when borrowing money. A score under 580 means your credit is in pretty rough shape and there’s a good chance you won’t be approved for a loan at all.

When it comes to what’s considered bad credit by mortgage lenders, it varies. Different lenders have different underwriting standards, and credit scores can play a bigger or smaller role in your overall approval chances depending on other factors, such as income, assets and the property you’re financing.

Typically, however, you’ll experience some friction if your score is between 620 and 740, according to Yves-Marc Courtines, a certified financial planner and former mortgage banker who now runs Boundless Advice in Manhattan Beach, California. He said a score in this range can result in a slightly higher interest rate, having to pay mortgage points or being restricted in how much you can borrow.

A credit score of 620 is considered the cutoff for getting a mortgage from traditional lenders.

“Buying a home with poor or bad credit is an option, but you may need to go through lenders of unconventional means,” said Abel Soares III, a former loan officer who is now a certified financial planner and CEO of Hui Malama Advisors in Honolulu. “This means that you may have to go through private lending or mortgage brokers and not your local bank.”

Bad Credit Mortgage Lending Options

Soares noted that with mortgages through private lenders (which include individual investors and “hard money” lenders that often finance individual properties), the interest rate for a borrower with bad credit will be higher and the minimum down payment will likely be heftier. “Keep in mind that if interest rates rise, you will be stuck with the existing mortgage and rate, so you want to make sure that you can afford the payment for the long haul,” he said. However, it might be better to rehab your credit score and refinance at a lower rate in the future. If you had to accept a prepayment penalty on the loan, check that the terms don’t make a refi even more expensive. Also, watch for “creative” loan structures that can saddle you with unaffordable payments after the first few years.

You might also be subject to stricter underwriting standards, which are the lender’s requirements to prove you qualify for the loan.

“There are often different underwriting guidelines, and the lenders may have you submit documentation different than your standard mortgage application,” Soares explained. In other words, be prepared to jump through a few more hoops if your credit is fair or very poor.

But private lenders aren’t your only options. Here’s a look at what else you can do to get approved for a mortgage with bad credit.

Give Government-Backed Loans A Shot

According to Courtines, a mortgage backed by the Federal Housing Administration (FHA) is probably your best bet if your credit score is under 620. In fact, even with a score as low as 580, you can qualify for an FHA mortgage with as little as 3.5 percent down. If your score is lower than that, you’ll be required to put at least 10 percent down. The credit score cutoff for FHA loans is 500.

However, there are a couple of downsides. FHA loans require you to pay an upfront mortgage insurance premium of 1.75 percent of loan value, plus monthly private mortgage insurance (PMI) premiums of 0.45 to 1.05 percent of the loan value. If you put less than 10 percent down, you have to pay PMI for the duration of the loan. Plus, the loan amount is capped at $679,650.

If you’re a service member or veteran, you might qualify for a VA loan. According to Courtines, VA mortgage lenders typically require a credit score of at least 620, but it is possible to find some that will accept a 580. VA loans don’t require a down payment, but you do have to pay a funding fee, typically 2.15 percent of the loan value. Most loans are capped at $453,100.

Make Up For Bad Credit With More Cash

Since a low credit score is a sign to lenders that you’re a riskier borrower, offsetting some of that risk can help increase your chances of getting approved for a mortgage. One way to do that is to offer up a bigger down payment.

According to a National Association of Realtors study from December 2016 to November 2017, 61 percent of first-time homebuyers put down 6 percent or less. But offering 20 percent or more will put enough of your own skin in the game that a lender might decide to lend to you despite your less-than-great credit. Plus, with more money down, you’ll enjoy lower monthly payments and won’t have to pay for private mortgage insurance.

Lower Your DTI

Another factor lenders consider is your debt-to-income ratio, or DTI. This figure represents how much of your income goes to monthly debt obligations, such as credit card, student loan and car loan payments.

The lower your DTI, the better, since you’ll have more income available to handle a mortgage payment. Usually, lenders require a DTI of 43 percent or less, though 36 percent is ideal. If you have bad credit, a low DTI ratio might make you a more attractive borrower. You can lower your DTI by either increasing your income or paying off some debt (or both).

Enlist A Co-signer

If you have a close family member or friend with good credit, you could consider having them co-sign the loan. A co-signer essentially lets you use their good credit to get approved ― but it’s not a decision that should be taken lightly.

Though the mortgage would be in your name, your co-signer would be equally on the hook for payments. So if you missed a mortgage payment, their credit would take a hit. If for some reason you decided to stop paying your mortgage, the lender could go after your co-signer for the money. Obviously, working with a co-signer requires a trusting relationship ― one that could be broken if you don’t handle your mortgage loan responsibly.

Consider Doing This Instead

Sometimes taking out a mortgage under less-than-ideal circumstances is the only way to get your foot in the door, so to speak. But, if you can, consider waiting and repairing your credit first.

“Over the years, working hard to improve... credit has yielded great returns for individual clients,” said Courtines. With good credit, you can save yourself the cost of higher interest rates and less favorable terms. It might seem like a lot of work now, but it can save you thousands in the long run.

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