You've found your dream home and made an offer. Now comes the hard part: getting a home loan to finalize the purchase.
Applying for a mortgage means putting your finances, including your credit score, in the spotlight. A bad credit score could add an extra wrinkle or two to the mortgage approval process.
"While getting a mortgage with bad credit is not always easy or optimal, it's still possible under certain conditions," says Daniela Andreevska, content marketing director at Mashvisor, a real estate data analytics company. A better question might be whether you should get a mortgage with bad credit.
This guide breaks down everything you need to know about getting a mortgage with bad credit, along with tips on how to decide whether it's the right move.
What's Considered Bad Credit for a Mortgage?
What's considered bad credit for a home loan can vary from lender to lender.
"It's important to realize that different lenders have different guidelines on what constitutes bad credit," says Jennifer Beeston, vice president of mortgage lending at online lender Guaranteed Rate.
[Read: The Best Mortgage Lenders.]
Beeston says the typical base credit score allowed for conventional mortgages is 620, although some lenders may require a higher score. Knowing where your credit score lands on the spectrum can help you narrow down your mortgage options. FICO credit scores are the most widely used scores for lending decisions, including mortgages. These scores range from 300 to 850.
FICO Score Rating
800 or higher
740 to 799
670 to 739
580 to 669
579 or below
What's considered a fair or poor score according to FICO might be deemed bad credit by a mortgage lender, depending where you are in the range.
What Types of Mortgage Loans Can You Get With Bad Credit?
When you're looking for a mortgage and you have bad credit, government-backed loans may be the best option. The government doesn't make loans directly; instead, it insures loans offered to eligible borrowers.
Government-backed loans include Federal Housing Administration loans, U.S. Department of Veterans Affairs loans and U.S. Department of Agriculture loans. Each one is designed with a different borrower in mind and has different credit score requirements.
Credit Score Minimum
Borrowers with a fair credit score and a down payment of less than 20 percent
580 for a 3.5 percent down payment; 500 to 579 for a 10 percent down payment
Low- or moderate-income homebuyers living in designated rural areas
Beeston says borrowers with FICO scores of 620 or below may want to set their sights on an FHA loan if they're not eligible for a VA loan. There's one thing to note, however: FHA lenders aren't required to make loans for borrowers with 580 credit scores. Some may raise the bar higher and require a 620 to 640 FICO score instead.
So where can homebuyers find these types of loans? The government guarantees loans from a wide network of lenders, both traditional and alternative mortgage lenders. The latter includes online lenders, some of which offer bad credit home loans and use nontraditional underwriting methods to get a sense of a borrower's ability to repay a loan.
If you prefer to get a conventional mortgage not guaranteed by the federal government, you may be able to qualify. But it may be easier to qualify with a government-backed program, so it's a good idea to investigate these options if your credit is less than ideal.
Again, the minimum credit score lenders look for can vary. And they can also impose different requirements on other factors, such as:
-- The minimum down payment required
-- The maximum debt-to-income ratio allowed
-- The types of properties borrowers can use a mortgage for
-- Minimum or maximum income allowed for a loan
-- Origination and other lender fees
As with any large purchase, you should shop around and compare bad credit mortgage terms from multiple lenders. It also helps to do the math to see what getting a mortgage with bad credit might cost.
How Bad Credit Affects the Cost of Buying a Home
Along with other factors, such as debt, assets and income, mortgage lenders use credit scores to gauge risk. Credit scores influence not only whether a borrower can get approved for a loan, but the interest rate he or she will pay for a mortgage. The better your FICO score, generally the less you can expect to pay for a home loan.
[Read: The Best Mortgage Refinance Lenders.]
For example, myFICO.com's loan savings calculator estimates you'd pay a 4.139 percent APR if your credit score is 760 or above. So, for a 30-year fixed-rate mortgage of $300,000, you might expect to pay more than $224,000 in interest over the course of the loan. However, if your score is between 620 and 639, myFICO.com's calculator estimates you'd pay a 5.728 percent APR. So if you had the same mortgage, you'd pay nearly $329,000 in interest. And you can expect to pay even more interest if your score falls below that threshold.
These calculations don't account for down payment or loan type, which can result in some variation in the total interest paid. But they do show how much of a difference a higher APR from a lower credit score can make in buying a home.
Tips for Getting a Mortgage With Bad Credit
When you're planning on getting a mortgage and you have bad credit, there are things you can do to improve your odds of getting approved or landing more favorable loan terms. Andreevska says getting a co-signer is one path to consider.
"If you have a bad credit score, you might still have a chance to qualify for a conventional mortgage but not necessarily on your own," she says. "You can get a family member or friend with a good score to co-sign with you," which may help you get approved.
A word of caution about co-signers, however: "This is a major responsibility, as anything you do, such as missing a payment, will hurt your co-signer's credit score, as well as your own," Andreevska says.
Before reaching out to a potential co-signer, consider whether you're in a strong enough position financially to keep up with the payments. And also think about how quickly you might be able to improve your credit score so you can eventually refinance the loan into your name only, releasing the co-signer of responsibility.
Making a larger down payment is also something to think about if you're not comfortable with the idea of a co-signer.
"This will decrease your risk of default, so a lender might be willing to make a loan," Andreevska says. However, "you should only put as much money down as you can really afford."
If making a larger down payment would leave you with no money to cover expenses such as closing costs, fees, homeowners insurance or repairs once the home is yours, you may want to hold on to your cash. Alternatively, you could ask family members to gift you money to put toward your down payment.
Consider Improving Your Credit Score Before You Buy a Home
Getting a mortgage when you have bad credit is certainly possible, but if you don't need to buy a home right away, you may want to work on raising your credit score first.
"If you know there are black marks on your credit, such as late payments or accounts in collections, start making serious credit repair efforts at least six months in advance of applying for a home mortgage," says Glenn Brunker, mortgage executive at Ally Home, the direct-to-consumer mortgage lending arm of Ally Bank. "If you can wait a year before applying for a home loan, that's an even better time frame to get your credit and finances into top shape."
Brunker says the first thing to do is make sure you're paying bills on time, "since payment history is the No. 1 factor that goes into a person's FICO score."
In addition to establishing a positive payment history, paying credit card balances on time could also improve your credit utilization ratio, which is the amount of your total credit limits you're using at any given time. An ideal credit utilization ratio is about 7 percent, but anything under 30 percent could help raise your credit score.
Beeston says an easy way to stay on top of due dates is setting up automatic minimum payments from your checking account, then making sure you have the funds available in your account to cover the payment. Alternatively, you can set up alerts with your accounts to let you know when a due date is approaching.
Finally, while you're working on your score, hold off on applying for new loans or credit lines.
"Consumers should avoid applying for a new credit card around the time they're applying for a home loan since that requires a credit check, which can negatively impact your credit score," Brunker says.
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