Contrary to popular belief, people with bad credit may still qualify for a home loan.
You can find lenders with mortgage programs designed specifically for borrowers with little credit history or records of loan delinquency in the past. Moreover, you can increase your credit score and eventually refinance an existing loan to get better a better rate.
Here are essential things that you should know about your FICO credit score and seven ways to increase your chances of getting mortgage financing – even if your credit is far from being stellar.
Read more: 7 red flags that could ruin your mortgage application
Quicken Loans requires a “fair” score of 620 or higher while United Wholesale Mortgage needs you to have at least a “fair” score of 640 to qualify for conventional mortgages.
But what exactly is a “fair” credit score?
The average score was 711 and the bare minimum to be considered fair was 580, according to credit rating company Experian.
Experian also reported that 46% of Americans have very good to exceptional ratings (740–850), while 16% have very poor scores (300–579). Lenders tend to be wary of the latter because they are more likely to default.
There is no minimum FICO score that will entirely disqualify you from getting a mortgage, but you are likely to get rejected if you’re in the mid-600s or lower.
Even if you qualify, you will have to pay more over the life of the loan due to high interest rates and closing costs.
To demonstrate, the annual percentage rate (APR) for people with exceptional credit scores of 760 and up was 2.369% in 2020. Using myFICO’s loan calculator, their total payable interest would be around $99,000 based on the average 30-year loan of $248,640.
Meanwhile, the APR for borrowers with scores below 640 was 3.96%. They would have to pay an interest of $177,000 or 79% more.
But don’t lose hope. Here are ways that you can increase your chances of qualifying for a mortgage and getting a good deal despite your poor credit.
Government-backed loans are less risky for lenders and have less stringent requirements when it comes to your credit score, debt-to-income (DTI) ratio, and down payment.
For example, you can apply for an FHA loan if you haven’t purchased a house in the last three years or you’re a first-time homebuyer. Backed by the Federal Housing Administration, you can probably qualify with a score of 500–579 if you can make a 10% down payment.
You should also consider a VA loan which is insured by the Department of Veteran Affairs. Under this program, you can qualify with a credit rating of around 580 with zero down payment if you’re a veteran or actively serving the armed forces.
Read more: The 7 most popular types of mortgage loans for home buyers
It’s possible to have both a low credit score and substantial savings. Lenders will likely approve a borrower with bad credit in exchange for a down payment that’s 10% to 20% of the property’s value.
Moreover, paying 20% down for a conventional mortgage can save you more money in the long run. This is the minimum requirement to avoid paying insurance on top of your monthly mortgage payments.
There’s no clear-cut rule on how large the down payment should be, but it may vary depending on your location and the type of mortgage you are qualifying for.
It is a red flag for underwriters to see negative items on your credit report, but writing a good letter of explanation can help your case.
“You may need to provide a letter of explanation for any negative items on your credit report, including missed payments, defaulted loans, or repossessions,” says Quicken Loans. “The letter should include an explanation regarding the negative event, the date it happened, the name of the creditor, and your account number.”
You should let the lender know that you can manage your finances well and wrinkles on your credit history were due to difficult and reasonable situations.
Read more: Why black homeownership rates are 35% behind whites’
Lenders may still approve low-credit applicants if they have guarantors who will cover the mortgage in case of defaults.
A guarantor is typically an immediate family member in better financial standing. They need to provide proof of their income and good credit standing, as well as sign a legally binding agreement.
The guarantor’s name will appear only on the mortgage and not the title, so they will not have rights over the property.
Furthermore, the lender will typically exhaust all means of collection from the primary borrower before the guarantor becomes liable for repayments.
You have better chances at qualifying with poor credit if you can make a larger down payment. If saving up is a struggle, you can use money that is “gifted” by a family member.
Note, however, that this must not be a loan and you should have no obligation to pay the money.
Additionally, the gift must be properly documented and declared to your lender. Otherwise, the underwriter may flag the money as a new loan or a deposit from an unacceptable source.
Mortgage brokers serve as an intermediary between would-be borrowers and lending institutions. Besides saving you effort and time, they can help you find the best mortgage terms that match your situation.
Choosing this route can be viable for applicants who are dealing with bad credit, are self-employed, or with have non-W2 income. Brokers will take care of loan shopping and match you to a lender that can accommodate your unique financial situation.
One potential downside to using a mortgage broker is the cost. Brokers are usually paid a commission that’s 1% to 2% of the total amount, and that can be pricey especially for large-sized loans.
Read more: 7 questions from first time home buyers that every broker needs to answer
You can refinance a mortgage with bad credit, so you’re not stuck with an unfavorable interest rate over the life of the loan. To get a better deal, you need to proactively rebuild your credit score through various means.
First, you need to settle past-due accounts and stop missing payments moving forward. After all, your credit report can show late payments for up to seven years from the date of delinquency.
Keeping all accounts current is a good and straightforward way to avoid new delinquencies and pull your score up.
You must also establish a good credit file. Start with secured credit cards or credit-builder loans if you still lack credit history or you want to boost your standing. You can also ask a close relative to add you as an authorized user on their credit card, assuming that they pay responsibly.