Finding a Mortgage When You Have Bad Credit

Having poor credit doesn’t automatically stop you from buying a home. Use this article to learn more about bad credit mortgage options.

Buying a home is one of the biggest events in your life and, very likely, the most expensive purchase you ever make.

In addition to being a place where you sleep at night and raise your family, your home is also a major investment.

Going through the home buying process can be stressful enough as it is, but for those of you with bad credit, it can be even more overwhelming.

You may be asking yourself if you'll even be able to buy a home with the kind of credit history you have.

Fortunately, you've got plenty of options, and you can still buy a home even if you have bad credit.

Bad Credit Mortgage Options

FHA Loans

If you have bad credit and can't put much money down, your best option is an FHA loan, because they only require down payments as little as 3.5% of the purchase price.

Other mortgage loans typically require a 20% down payment, so you can save a ton of money up front with an FHA loan.

You can get approved for an FHA loan even with a credit score in the 500s. But if you fall within the 500-579 range, you'll have to make a 10% down payment.

There are other requirements as well.

You need to have worked at the same job for the last two years at a minimum, and they only accept applications from US citizens with a valid social security number who meet the legal age requirements to sign a mortgage in that particular state.

You must have the property appraisal made by an appraiser who is approved by the FHA.

Your front-end ratio must be less than 31% of your gross annual income.

This is the total amount of your mortgage payments, plus your taxes and insurance.

There are instances when you can get approved if this percentage is as high as 40%, but the lender needs to justify your situation.

The back-end ratio must be less than 43% of your annual income, but again, lenders can approve you if that number is up to 50%.

Your back-end payments include things like credit card payments, student loans, and car payments.

If you've previously filed for bankruptcy, you must be out of bankruptcy for more than two years before applying for an FHA loan.

Exceptions can be made if you're one year out of bankruptcy and there were certain extreme circumstances.

Mortgage insurance is required for all FHA loans.

First time home buyers with bad credit are great candidates for FHA loans because 100% of the down payment can be gifted by a family member or friend.

There are even certain programs that don't require any down payment for first-time buyers.

VA Loans

This is another type of loan that's backed by the Veterans Administration.

In order to qualify for a VA loan, you must be US veteran or the spouse of a deceased veteran who has not been remarried.

The requirements for a VA loan aren't quite as lenient as an FHA loan, but they still help people with lower credit scores.

Usually, you need to have a FICO score that's 620 or higher to qualify.

But there are certain lenders that will work with borrowers who have a score around 580.

Rural Development Loans

The US Department of Agriculture (USDA) encourages people to own homes in rural neighborhoods and these mortgage loans were designed for families with low to moderate incomes.

So if you're purchasing a home in one of these areas, it's worth consulting with a lender to see if you qualify for the terms.

The best part about USDA rural development loans is that they don't require any down payment, so 100% of the purchase is financed.

This means that lenders will have to loan borrowers larger amounts of money, which makes these loans a bit more risky for them.

That's why most lenders require credit scores above 640 to qualify.

Find a Co-signer

If you're struggling to find a loan that you qualify for, or if you're not comfortable with the terms of the loan that you were approved for, you're not out of options just yet.

A co-signed loan is common for younger generations who get help from one of their parents.

The co-signer guarantees repayment to the lender and they become equally responsible for the debt.

So, if you fail to repay your mortgage, your co-signer is on the hook for this as well.

The great part about a co-signed loan is that you'll be able to get terms that are more favorable, because lenders will review the credit score of the co-signer to determine the loan terms.

So if your co-signer has excellent credit, it's going to save you interest charges over the lifetime of the loan.

Tips for Getting a Mortgage if You Have Bad Credit

Now that you know more about your mortgage options, here is some extra information you need to know before you apply.

Review Your Credit Report

You won't be able to determine which mortgage loans you qualify for if you don’t know your credit score. So before you visit a bank or start making appointments with real estate agents, check your credit report.

As you can see, a large percentage of the American population checks their credit report more than once per year. 2018 Average Credit Score By U.S. Region

But if you fall into the group of people who don't check their report, then that needs to change.

You’ll also want to review the report in detail and understand what factors make up your credit score. Once you recognize how your credit score is calculated, you'll be able to identify which parts of the credit report are hurting you.

Your payment history is the biggest factor, as late payments or missed payments will cause your credit score to drop.

The amounts owed and your overall debt both play a role as well.

If you have lots of outstanding balances, it will impact your credit utilization ratio, which is the percentage of credit that's currently being used.

If you're maxing out credit cards, chances are you have a high utilization ratio, which will lower your score, and it makes you appear as more of a risk to potential lenders.

There are other factors that contribute to your credit score as well, such as the length of your credit history.

This includes the age of your oldest account as well as the average age of your overall credit.

Factors like your credit mix and new lines of credit aren't weighed as heavily, but they still contribute to your credit score.

Once you recognize how your credit score is calculated, you'll be able to identify which parts of the credit report are hurting you.

In addition to looking at your credit score, check the report for any errors. If you find mistakes, dispute the errors.

If you can get these marks removed, your credit score will increase, and you'll be able to qualify for more loans than you initially realized.

Get Your Finances in Order

Now that you know exactly why your credit is low, you need to make an effort to fix it.

You can't expect to eliminate a lifetime of poor financial management in just a few days, but making an effort will show prospective lenders that you're serious about the loan application and responsible enough to be trusted with their money.

So do your best to pay off any outstanding balances.

When you purchase a home, your mortgage loan will obviously have a high outstanding balance.

Lenders won't be comfortable adding to your outstanding balances if you can't pay off your other debts, so even if you can't bring your balance down on all of your accounts to zero, at least try to get as close as possible.

You also need to be able to prove that you have a steady income.

Without preparing the proper documentation, lenders won't know if you're able to make your monthly mortgage payments just based on your word alone.

The longer you've been at the same job, the better it looks on a mortgage application.

But if you've been bouncing around different jobs in the last few years, it may be in your best interest to wait until you have stabilized your place of employment for a while before you consider applying.

An applicant's job stability is of utmost importance to mortgage lenders, especially if you have bad credit.

Have a Realistic Budget

Don’t wait until after you apply for a mortgage loan to start budgeting. You want to start the process knowing what you can afford as a down payment and the monthly payment amount that makes sense for your finances.

When considering what you can afford each month, keep in mind all of the costs associated with your mortgage.

There is the down payment which gets paid directly to the seller.

Then your loan amount plus interest charges will be broken down into monthly payments back to the lender.

You'll have additional monthly payments as well, which include property taxes, homeowner's insurance and, in some cases, mortgage insurance.

Buying a home means you need to be prepared to pay closing costs, which are paid during the closing, on the day of the final sale.

Sometimes these closing fees can be negotiated. You may even be able to split them with the seller or get the seller to cover them completely.

But either way, you need to be ready to pay additional fees.

Plus, factor in all of your other monthly living expenses after you move in, such as your utilities.

Saving money and budgeting accordingly will make it much easier when you approach a lender, especially if you can pay a substantial down payment.

Know What Down Payment You Can Afford

Now that you have a realistic budget, you'll also know of what type of home you can afford to purchase, and what makes sense for a down payment.

A larger down payment also means that you'll borrow less from the lender, which makes them more comfortable loaning money to someone who has bad credit.

However, you still need to be prepared to pay higher interest charges, because you just won't get offered the same rates as people with excellent credit scores.

The down payment also plays a role in whether or not you get a mortgage. Lenders will most likely evaluate your credit score, debt-to-income ratio, and loan-to-value ratio when deciding if they’ll approve your mortgage.

The loan-to-value ratio, or LTV is the mortgage amount divided by the appraisal value of the property times 100.

You can read more about it here, but in general, a lower LTV is seen as less of a risk for the lender. If you can afford a higher down payment, it will help lower your LTV.

Find a Lender

Shopping around for a mortgage loan is just as important as shopping around for your new home. Before you start shopping for a home, you should make appointments with a few different lenders.

Don't assume that the first person you speak with is going to offer you the same options as everyone else.

You're not obligated to sign any contracts or make anything official during your meetings.

Just consult with the lender about your current financial situation.

Lenders can give you suggestions on how to qualify for different types of mortgages with bad credit, and may even be able to give you a ballpark idea of what you can afford.

It won't be an official pre-approval letter, but a lender can still run some numbers based on your credit score, income, and down payment amount to give you a better idea of what price range you fall into.

This pre-qualification process is common for people trying to secure a personal loan as well as mortgage loans.

Don't assume that you need to get a mortgage loan from a bank. Average U.S. Mortgage Rates (March 2018)

In fact, last year more mortgages were offered by credit unions than banks.

Credit unions are also more likely to work with people who have bad credit scores, since they have the ability to offer more favorable loan terms and interest rates as well.

That's because they are owned by members, as opposed to banks that are owned by shareholders.

Sit down with your lender and explain your reasons for having bad credit. If there are mistakes or isolated instances from your past, they may be willing to look past them.

Show the lender that you've made recent changes to improve your credit, such as letting them see how you've been making payments on time and how you've paid off outstanding balances.

Explain that you have a steady job and provide documentation or records of your income, which we previously discussed.

Always be honest and upfront about your financial situation, as opposed to lying or withholding information.

If you aren't truthful, this can come back to haunt you as it will cause distrust between you and the lender, who ultimately won't be willing to loan money to someone who they can't trust.

Review All of Your Options Before You Apply

Don't rush into a mortgage without doing the right amount of research.

Since this is a major life decision where there's lots of money at stake, it's important for you to understand all the basics and make the necessary preparations before you go ahead and search for the best places to get a loan with bad credit.

Know your credit score and thoroughly review your credit report.

Consider postponing applying for a loan until your finances are in order and you can improve your credit score.

Budget accordingly and recognize what you can and can't afford.

If you can pay a large down payment, it will increase your chances for approval.

For those of you who can't afford a down payment, consider FHA loans, VA loans, or rural development loans.

You might also want to look for a co-signer to leverage their credit to help get approval.

Follow the advice that I outlined in this guide if you want to get approved for a mortgage loan despite having bad credit.

Have you been recently approved for a mortgage?

How was your experience going through the mortgage loan approval process?

We'd love to hear about it!

Tell us your story in the comments below.

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