How to Get a Mortgage with Bad Credit

It’s not impossible to get a mortgage with bad credit, but it’ll take some work. Here are four tips to help you improve your credit score.

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Introduction

It’s not impossible to get a mortgage with bad credit, but it will be more difficult to get approved for a loan and you’ll likely pay a higher interest rate. Before you start shopping for a home, it’s important to understand your credit score and what it means for your ability to obtain a mortgage.

A credit score is a three-digit number that lenders use to evaluate your creditworthiness. It is calculated based on your payment history, outstanding debts and other factors. A high credit score indicates that you are a low-risk borrower, which makes you more likely to be approved for a loan.

If you have bad credit, there are still options available to you. The first step is to understand your credit score and what factors are affecting it. Once you know where you stand, you can begin working on improving your credit so that you can qualify for a better mortgage loan.

Check Your Credit Score

If you have bad credit, the first thing you should do is check your credit score. You can get a free copy of your credit report from each of the three major credit reporting agencies — Equifax, Experian and TransUnion — once every 12 months.

Review your report for errors and dispute any inaccuracies with the credit bureau. This is important because your credit score is based on the information in your credit report.

Once you have a copy of your report, you can begin to work on improve your credit score.

Find a Lender

There are a handful of direct lenders and many more mortgage brokers who work with people with bad credit every day. While their exact terms will vary, these lenders generally offer loans with lower credit score requirements than banks or credit unions.

To find the right lender for you, start by shopping around. Compare offers from a few different lenders to see which one offers the best terms. Be sure to compare APRs, not just interest rates. A low interest rate could end up costing you more if it comes with a high APR.

Once you’ve found a few lenders that seem promising, get in touch and start the application process. The sooner you start, the sooner you’ll know if you’ve been approved.

Get Pre-Approved

The first step is to get pre-approved for a mortgage. Your credit will be pulled, and the lender will look at your income, debts and credit score. They’ll then give you a letter saying how much house you can afford and what interest rate you’ll pay on your loan. This is called a “pre-approval.”

Shop Around

There are two types of mortgage lenders, depository institutions and nondepository institutions. Depository institutions include banks, credit unions, and savings and loans; nondepository institutions include finance companies and mortgage bankers. Although most lenders will deny your mortgage application outright if you have bad credit, some may be willing to work with you if you have a low credit score. Shopping around is the best way to find a bad credit mortgage lender who is willing to work with you.

One thing to keep in mind when shopping around for a bad credit mortgage is that lenders will most likely require a higher interest rate and down payment than they would for a borrower with good credit. Be sure to compare rates and terms from several lenders before signing any loan agreement.

Understand Your Mortgage Options

There are two types of conventional loans available to borrowers with bad credit: conforming and non-conforming loans. Conforming loans follow lending guidelines set by government-sponsored enterprises, such as Fannie Mae or Freddie Mac. Non-conforming loans don’t follow these guidelines. They may have higher interest rates and require a larger down payment than conforming loans, but they may be an option for borrowers with bad credit who don’t qualify for conforming loans.

VA Loans
The U.S. Department of Veterans Affairs (VA) guarantees home mortgages for eligible active duty service members, veterans and surviving spouses. VA loans are available through private lenders, and the VA guarantees a portion of the loan, making it easier for borrowers to qualify and sometimes resulting in lower interest rates. VA loans can be used to finance up to 100% of the purchase price of a home, and they don’t require private mortgage insurance (PMI).

FHA Loans
Federal Housing Administration (FHA) home loans are insured by the government and offered by participating lenders. Borrowers with credit scores as low as 580 can qualify for FHA loans, although there may be some additional requirements, such as providing proof that any derogatory items on their credit report were due to extenuating circumstances beyond their control. FHA loans can finance up to 96.5% of the purchase price of a home and also allow gifting or grants for part or all of the down payment funds.

Be Prepared to Pay a Higher Interest Rate

A bad credit score means you’re going to pay more for your mortgage. That’s because lenders see you as a higher risk to default on your loan. But just how much more?

The average cost of a 30-year fixed-rate mortgage for a borrower with a credit score of 580 is 4.40%, according to MyFICO. That’s more than 4 percentage points higher than the average cost for a borrower with a credit score of740.

To get the best mortgage terms available, you’ll likely need a credit score of 760 or higher. But don’t despair if your score is lower than that. There are programs available for homebuyers with bad credit, and you can improve your credit score over time by taking steps like paying all your bills on time, reducing your debt and keeping your credit balances low.

Have a Larger Down Payment

A larger down payment is often required when obtaining a mortgage with bad credit. This is because lenders will view you as a higher-risk borrower and, as such, will be less likely to approve your loan if you have a smaller down payment. Aim to have a down payment of at least 10 percent of the purchase price of the home, or 20 percent if you are applying for an FHA loan.

Consider an FHA Loan

If you have bad credit, you’re not alone. According to the Federal Housing Administration, 11 percent of borrowers had FICO scores below 580 in 2010, and the average credit score was 686. If your score is below 580, you’ll trouble qualifying for a conventional mortgage. But if you’re able to squeak by with a 580 credit score, you’ll be looking at a larger down payment than someone whose score is closer to the average.

With that in mind, if you’re determined to get a mortgage with bad credit, consider an FHA loan from the U.S Federal Housing Administration. A lower down payment (just 3.5 percent of the loan amount) is required, and your Loan-to-Value ratio can be as high as 96.5 percent with this program (as opposed to 80 percent for conventional loans). An FHA loan might be an option for you even if your credit isn’t perfect; scores as low as 500 are accepted with 10 percent down, and scores from 501-579 qualify for 3.5 percent down.

For more information about this program, check out our guide to FHA loans or speak to a local HUD-approved lender.

Get a Cosigner

A cosigner might be a family member, friend, or anyone with good credit willing to sign for you. Because the cosigner shares responsibility for the loan with you, the lender feels more confident loaning you the money. As a result, cosigners can help you qualify for a mortgage when you otherwise couldn’t.

Of course, when someone co-signs your mortgage, they become just as responsible for making payments as you are. That’s why it’s important to ask someone only if they’re willing and able to make payments on the loan if you can’t.