You want to buy a new home but your credit score is low. Does this mean you’re out of luck? It depends.
The good news is that you have several options and loan programs to help you out. The bad news is, without excellent credit, you will undoubtedly have to pay higher interest rates.
Some lenders will give you the side eye or tell you to try again when that magic three-digit number is higher. But with a little legwork, it’s possible to get a mortgage with bad credit. Keep reading for tips to help you get approved.
Know Your Credit Scores
How low are your credit scores? Do you know what’s causing you to have poor credit? Or are you assuming it’s bad because of past financial missteps?
What is a ‘bad’ credit score?
What constitutes a bad credit score? Generally, the ranges are as follows:
- Excellent: 781 and above
- Good: 661-780
- Fair: 601-660
- Poor: 501-600
- Bad: 500 and below
So, if your credit score is 600 or lower, you’d fall into the subprime consumer category.
How Your Credit Scores are Calculated
You should also have an understanding of how your score is calculated so you’ll know how much to beef it up before applying. The five components are as follows:
- Payment history (35%): Do you make timely payments to your creditors each month? If you’ve missed several payments in the past, your credit could be suffering. And other past-due bills that became collection accounts also negatively impact your payment history.
- Amounts owed (30%): How much do you still owe creditors? If your debt to available credit or credit utilization ratio on revolving accounts is high, your credit could be suffering.
- Length of credit history (15%): How long have you had credit? A more established credit profile could equate to a higher FICO score.
- Credit mix (10%): Do you have a healthy mix of revolving and installment credit? Lenders like to see a combination of both, and having several of one and not the other could lower your credit score.
- New credit (10%): Have you recently opened several new credit accounts? If so, prospective lenders may see you as more of a risk.
How to Check Your Credit Score
There are several free options to choose from, but you can start by contacting your bank to see if it’s a service provided to account holders, free of charge. Or if you have credit cards, check the statement or online dashboard as it may appear there.
Did you recently apply for a mortgage and were denied? The lender is obligated to send you a letter explaining their decision and disclose that you can request a copy of the credit report used to make the decision.
In some instances, the denial letter will provide a few key bullet points explaining the denial and the credit score the lenders used during the evaluation process. While lenders use different algorithms and credit scoring models, using this number as a base to see where you stand.
Rectify Errors in Your Credit Report
According to the results of a study conducted by the Federal Trade Commission (FTC), 20 percent of credit reports contain errors. But why does this matter? Well, what’s in your report determines your score. And there’s a possibility that an error could be tanking your score and standing between you and a mortgage.
So, you’ll want to get a free copy of your report and review it from top to bottom. If you spot errors, take the following steps to have them rectified:
- Step 1: Print out a hard copy of your credit report and circle the items in question.
- Step 2: Draft up a letter of dispute to submit the credit bureaus. For a template, click here.
- Step 3: Send the letter, the highlighted copy of your credit report, and any supporting documentation to the credit bureaus.
- Step 4: Follow-up in writing with the credit bureaus after 30 days if you still haven’t received a response.
If you need additional help with credit report errors, review this comprehensive guide from the FTC.
Even if you can successfully dispute errors on your credit report, it can take a while for those updates to reach your credit report. Prepare to fix your credit at least a few months before applying for a mortgage. That way, you can ensure any positive changes have time to improve your credit.
What if all the contents are accurate?
There’s a possibility that a series of financial missteps or a rough patch has left your credit in shambles and the effects are still lingering. If that’s the case, reach out to the creditors and request that they remove the negative mark from your credit report in exchange for a settlement of the account in question.
This is called a pay-for-delete agreement and can do wonders for your credit if the creditor is on board. But be sure to get the agreement in writing.
If the account is showing as a paid collection item, this approach won’t work since the account has already been paid off.
However, you can write a letter to the creditor explaining your circumstances and ask that they honor a goodwill adjustment so you can get approved for a mortgage. You may not have luck with either approach right away, but consistency could pay off.
Run the Numbers
Mortgage loans designed for consumers with subpar credit sometimes come at a higher cost. Why so? It’s all a matter of risk.
The mortgage lender wants to be protected if you default on the loan and the home goes into foreclosure. So, if you’re adamant about getting a mortgage with bad credit, be prepared for the financial implications.
To illustrate, assume you’re seeking a 30-year fixed rate mortgage for $250,000. Below is an example of how the figures could play out, based on your creditworthiness:
|Credit Score||Monthly Payment||Interest Paid Over the Life of the Loan||Total Cost of the Loan|
And these figures don’t even factor in property taxes, homeowner’s insurance, and private mortgage insurance (if you make a down payment that’s less than 20 percent).
The good news is you can always refinance the loan at a later date when your score and financial situation improves.
Explore Loan Options
Federal Housing Administration (FHA) loans lead the pack with regards to mortgage products for consumers with bad credit. FHA loans are offered at several financial institutions and have less stringent qualification criteria than other conventional mortgage products. To qualify, you’ll need:
- A minimum credit score of 580. (Some lenders want to see this number at 620).
- A small down payment. If you don’t have 20 percent to put down, you may still qualify as the minimum amount is 3.5 percent. And there are grant programs in some areas to assist cash-strapped buyers. The only downside is you may be required to carry mortgage insurance for the duration of the FHA loan.
See also: FHA Loan Requirements for 2019
You can also use a lending network, like Lending Tree, to determine if you qualify for conventional mortgage loan products.
Another option: submit a mortgage application at your current financial institution. Although your credit is poor, they may be able to approve you off the strength of your long-term relationship with the bank. Plus, you have a better shot at pleading your case with a banker that knows you, and not a complete stranger.
Save Up for a Down Payment
Lenders may be reluctant to approve you for a home loan with poor credit. And the higher the loan amount, the more risk they’ll have to assume.
But if you bring a hefty down payment to the table, the likelihood of you being approved could increase since the loan amount will be lower. Plus, you’ll save a bundle on interest.
So, what’s a good percentage to aim for? The standard 20 percent required for most conventional home loans is a good starting point, but the higher, the better. (Plus, you may be able to avoid mortgage insurance).
It’s also a good idea to have a hefty amount of cash in your savings account. This demonstrates to lenders that despite your poor credit score, you can handle financial emergencies or cover unexpected financial occurrences as they arise. It’s not necessary to stow away an entire year of income in the bank, but three to six months will suffice.
Go Rate Shopping
Worried about your credit taking a hit if you apply with several lenders? Don’t be. According to myFICO, “inquiries for mortgage loans generated in a 30-day window count as a single inquiry.”
So, if you shop around and apply with ten separate lenders in a 30-day window, your credit will only be impacted by one inquiry since FICO scoring models recognize that you’re conducting a home loan search.
Sign on the Dotted Line
Congratulations! You’ve done your homework, saved up for a downpayment, and shopped around to find the lowest interest rate. Despite your credit troubles, you’ve done the legwork to buy the home of your dreams.
But if you weren’t as fortunate and found that it wasn’t the right time to buy, don’t fret. Be patient while working diligently to boost your credit and get your finances in order.
Also, be sure to make all your rent payments on time to show potential lenders that you are responsible and can handle your housing obligations. That way, you’ll have more luck next time around.