While a 20% down payment and a great credit history make buying a home easiest, there are ways to get approved for a home loan without them those golden assets. Programs, such as Federal Housing Administration or FHA loans, Veteran’s Administration or VA loans and United States Department of Agriculture or USDA loans can help those without great credit and a large down payment realize the dream of home ownership.
Why Mortgage Lenders Care About Credit Scores?
Your credit scores and credit reports are the primary information lenders use to determine whether you’re a good or bad risk for a mortgage. Assessing your creditworthiness also gives lenders an idea of the amount they can safely loan you with confidence you can pay it back and make payments on time.
Your credit scores and credit reports show a potential mortgage lender how you’ve handled past debt and payment obligations. Do you have several late and delinquent payments? Bankruptcies or other adverse judgments? Any of those items are red flags to a lender. And, because the lender is in the business of making money and not losing it, it wants to see you are not a risk.
Sadly, even if you’ve completely changed your credit habits, the lender will look at your past to assess whether or not it wants to enter into a future with you.
Even if you have a good credit score in the 750 range, a potential lender will look at your debt usage. If your usage is high, the lender might decide not to give you a loan. High debt usage is another red flag that loaning you money might be risky and result in a business loss for the lender.
Good and Bad Credit Home Loans
For first-time homebuyers and those looking for a second home, getting a traditional home loan with bad credit or a poor credit score can be difficult. But it’s not impossible. Even credit scores traditionally thought of as “bad” won’t necessarily stop you from getting approved for a mortgage.
Credit Score and Mortgage Approval
| Credit Score | Typical Lenders’ View of Score | Ease of Getting a Mortgage |
| 740–850 | Outstanding | High |
| 720–740 | Great | High |
| 700–720 | Good | Good |
| 680–700 | Risky territory | Medium |
| 620–680 | Quite risky territory and less than perfect, but will likely still approve a home loan | Medium |
| 550–620 | Wants improvement before approving a loan, but FHA loans are possible | Low |
| 300–550 | Leery to approve a home loan, but FHA loans are possible | Low |
Mortgage Options Less than Good Credit
If you have a score lower than 620, it’s unlikely you’ll receive approval for a traditional home loan, also known as a conventional fixed-rate mortgage. However, you can likely apply for other programs, such as FHA loans, VA loans and USDA loans.
If one of those programs isn’t an option, take some time to improve your credit by paying debts on time before you apply for a loan. While you may be approved for a mortgage loan with a credit score between 620 and 680, such a score will affect your loan program and pricing. It will also result in your paying a higher interest rate. So it’s well worth your while to improve your score first if you can.
To get help improving your score, you can sign up for your free credit score on Credit.com. Your score includes access to a free credit report card that shows where you stand in each of the five areas that go into your credit score and how you can improve each area.
If you have bad credit, then the primary option for you to buy a home is an FHA loan. If your credit score falls between 500 and 579 and you can make at least 10% down payment, you likely qualify for an FHA loan.
If your credit score is 580 and 620, the golden score for qualifying for a conventional loan, you will likely qualify for an FHA loan and only need a 3.5% down payment. Additional advantages of an FHA loan for people with lower credit scores include:
- Shorter wait times after negative credit events, such as foreclosure, short sale, bankruptcy and divorce
- Lower interest rates than conventional loans
- Acceptance of a higher debt-to-income ratio than conventional loans
Disadvantages of an FHA loan compared to conventional loans include longer times to get approved and the requirement of mortgage insurance, usually a 1.75% upfront premium and 0.45%–1.05% annual premium too. But, given that you can buy a home with a lower credit score, those are minor if home ownership is your dream.
VA loans and USDA loans are also options for some borrowers.
- VA loans are available to active military members with credit scores of 620 or higher, require no down payment, offer competitive interest rates and can be easier to qualify for than conventional loans
- USDA loans are available in rural areas to those with certain income levels and credit scores of 620 or higher, require no down payment, offer competitive interest rates and can be easier to qualify for than conventional loans
How Bad Credit Affects Your Home Loan
Your credit score determines two major things for a mortgage lender:
- The loan program or mortgage type
- Loan pricing, especially interest rate, which, if high, results in a higher monthly payment
Loan Programs
There are various types of loan programs, including conventional, FHA, VA and USDA mentioned above.
Conventional loans are best for borrowers with good to outstanding credit. But if you can make a large down payment, you might be approved for a conventional fixed-rate mortgage even with less-than-perfect credit.
Loan Pricing
When it comes to pricing, if you have lower credit, your mortgage interest rate for a conventional loan will most likely be higher than those of someone with good or excellent credit. You may also face additional premiums and more expensive insurance.
According to myFICO.com, the interest rate paid for 30-year conventional fixed-rate mortgage varies by credit score as follows:
| Credit Score | APR |
| 760+ | 4.058% |
| 620–639 | 4.647% |
That’s a difference in monthly payment of $289. The borrower with the lower credit score, pays the higher price.
Credit History and Your Home Loan
Your credit history is another factor a lender uses when deciding whether to approve your mortgage loan. Negative items on your credit report, such as patterns of previous credit delinquencies and balances on closed accounts, negatively affect your chances of getting approved for a mortgage.
Lenders look at credit scores first to determine which home loan you’re eligible for. Next, your complete credit overview, including credit history, is used to determine what the lender looks for in the underwriting process. During underwriting, the lender tries to figure out what happened in your credit history and why, as well as the likelihood that you’ll have credit issues in the future.
How to Overcome Credit Red Flags
Negative items can cause concern for lenders, but may not be total deal breakers. Here is a list of negative red flags and how to overcome them.
- A pattern of delinquencies. Lenders can work around a record of late payments, but they’ll likely require a larger down payment and lower debt-to-income ratio to do so.
- Late student loan payments. A late federal student loan payment within the last 12 months will make approval less likely for an FHA loan because government financing doesn’t look kindly at delinquent federal payments.
- Late mortgage and other loan payments. Lenders usually overlook one late payment in the past 12 months, so long as you can explain and provide necessary documentation.
- After a foreclosure, it takes 36 months to be eligible for a 3.5% down FHA loan and 48 months for a no-money-down VA loan. However, it takes seven years to qualify for conventional loan approval, no matter the size of the down payment.
- Short sale. Mortgage eligibility after a short sale is 36 months for a 3.5% down FHA loan and 24 months for a no-money-down VA loan or a 20% down conventional loan.
- With normal Chapter 7 bankruptcy, you have 24 months until you’re eligible for a 3.5% down FHA loan and 48 months for a VA loan or conventional loan.
To determine which red flags to overlook, lenders use mortgage overlays. Overlays are explained by The Washington Post as “the mortgage approval standards that lenders and their investors place above the guidelines set by Fannie Mae, Freddie Mac, the Federal Housing Administration and the Department of Veterans Affairs.” In other words, overlays are the guidelines mortgage brokers and lenders follow to prevent potential mortgage losses.
Overlays vary from lender to lender, so while one lender might not approve your loan because of poor credit and a minimal down payment, another may. The key is to find a lender with minimal overlays who is willing to work with your situation. One way to shortcut the path to finding a lender who will work with you is to go through a mortgage broker who can do the legwork for you.
Ways to Qualify for a Home Loan with Bad Credit
Even with bad credit, there are things you can do as a potential homebuyer to help improve your chances of loan approval.
Larger Down Payment
If you can’t quality or for a non-conventional loan, try saving money for a larger down payment. Lenders view borrowers with a combination of bad credit and no money down as riskier than either factor in isolation. Typically, lenders like to see at least a 20% down payment.
Lower Your Debt Usage
It’s also important if you have bad credit and are trying to secure a home loan, to lower your overall debt-to-income ratio. The debt-to-income ratio is a way a lender calculates how much you can afford.
Use Your Rental History
Most credit reports don’t contain information regarding past rental payments. However, if you can, prove you made on time payments consistently over the last 12 to 24 months. A few alternative credit reporting tools can help, like Rent Reporters, Rental Kharma and RentTrack.
Before choosing any tool, research the fees and monthly charges. Also, ask if your personal data will be protected and what you have to do if you choose to cancel the service. Some of these tools only report to one of the major credit bureaus. But some report to all three, which will help more than just one.
Explain Your Credit History and Circumstances
It may be helpful to write a letter explaining your situation. Break down the negative items currently on your credit report and give the reason as to why the lender should trust that it won’t happen again. Provide any proof you have that you’re taking care of the situation, paying down debt or receiving benefits because of an unexpected layoff and loss of employment, for example.
When you talk to a lender, gather documentation to explain your credit challenges. If you can explain derogatory items in your credit history to a lender, you’re more likely to receive a mortgage.
Be specific when speaking to a potential lender or broker. Don’t be afraid to share details of your needs and concerns. You’ll save yourself a lot of headaches later by finding out up-front if they have any mortgage overlays that might prevent them from lending to you.
Conclusion
You don’t have to have perfect credit to buy a home. Just be prepared and search carefully for the lender or broker who can make your dream home a reality.
Not sure where to start looking for a mortgage? Start right here at Credit.com with a list of mortgage rates from lenders in your area.
Image: Jupiterimages
This article was last published July 17, 2018, and has since been updated by another author.
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