How to Qualify for a Mortgage Loan with Bad Credit

The idea of purchasing a house can feel overwhelming, especially when faced with the challenge of starting the process with a bad credit history. It may seem nearly impossible to secure a loan under such circumstances. However, it is important to note that there is an option known as a bad credit home loan, which means that your credit score might not be as big of an obstacle as you initially believed.

Within this article, we will explore the available choices for individuals seeking to buy a house with bad credit and provide insights on how to qualify for a mortgage.

Remember, if you decide to purchase a home with bad credit, there is always the opportunity to improve your credit score and refinance your mortgage in the future, which can result in more favorable loan terms.

What constitutes a bad credit score in the eyes of mortgage lenders? 

The specific minimum credit score required can vary depending on the lender and the type of loan. Conventional loans typically demand a minimum credit score of 620, while government-backed loans tend to have more lenient credit score requirements.

If your credit score falls below 500, obtaining a mortgage may prove challenging, and it would be advisable to prioritize efforts towards increasing your score beforehand.

Is it Possible to Purchase a House with Poor Credit? 

When it comes to credit scores, having anything below a 670 FICO® Score is typically considered "subprime" by Experian™, one of the leading credit bureaus. Within the subprime range, Experian further distinguishes between fair scores, ranging from 580 to 669, and poor scores, encompassing anything below 579.

If you find yourself with bad credit, having cash on hand can be extremely beneficial, particularly when it comes to making a down payment. The reason behind this is that your credit score might only qualify you for a limited mortgage loan amount. However, if you can bridge the gap with cash, you still have the opportunity to afford the home you desire.

Additionally, the specific lender you work with will also impact your options, as each lender has its own set of requirements. While it is possible to obtain a loan with bad credit, it is crucial to be prepared for higher monthly mortgage payments due to elevated interest rates.

Strategies for Purchasing a House with Bad Credit

Let's explore some loan options that are available to individuals seeking to buy a house despite having bad credit. We will also delve into the typical credit score requirements associated with each option.

Conventional Loans 

Both Fannie Mae and Freddie Mac typically mandate a minimum credit score of 620 for conventional loans, although certain lenders might establish an even higher minimum threshold.

FHA Loans 

FHA loans are loans backed by the Federal Housing Administration, and they can be particularly appealing to first-time home buyers due to their more lenient qualifying criteria. Most lenders require a minimum credit score of 580 to obtain an FHA loan. However, a few lenders do offer FHA loans with a minimum score of 500, albeit with a 10% down payment requirement.

It is important to note that FHA loans have additional qualification prerequisites, such as being restricted to the purchase of a primary residence.

VA Loans 

If you are a veteran, the surviving spouse of a veteran, or currently serving in the armed forces, you may be eligible for a VA loan. VA loans are backed by the Department of Veterans Affairs and allow for purchasing a home with a $0 down payment. However, a one-time "funding fee" is typically required.

Although the VA does not impose a specific credit score minimum, most lenders do. For instance, Rocket Mortgage® sets a minimum credit requirement of 580 for VA loans.

USDA Loans 

USDA loans are another type of loan backed by a government department, namely the U.S. Department of Agriculture. These loans enable the purchase of a home in qualifying rural areas with a $0 down payment. Most lenders require a credit score of 640 to qualify for a USDA loan, along with other income requirements specific to this type of loan.

Remember, while these loan options provide opportunities for individuals with bad credit to buy a home, it is crucial to thoroughly research and evaluate the terms and conditions offered by different lenders to make an informed decision.

Depending on the type of mortgage, it may be possible to qualify with a co-signer. Having a co-signer can raise your credit profile, as their income and assets are considered alongside yours. It might also enable you to secure a larger loan amount despite having bad credit, giving you a broader range of options when house hunting. 

In most cases, a co-signer helps lower your debt-to-income ratio, improving your qualification chances. The median credit score of all borrowers typically determines eligibility. However, for loans backed by Fannie Mae, lenders are allowed to average the median scores of the borrowers. This can be a decisive factor in qualifying for the loan.

For example, if your median credit score is 580, and your co-signer's score is 720, recent Fannie Mae policy permits averaging the two scores to reach 650. Note that the lowest median score still determines the interest rate and mortgage insurance cost, potentially resulting in slightly higher rates. It's important to remember that credit score averaging does not apply to every loan option.

Considering these alternative options can help potential homebuyers with bad credit find viable paths to homeownership. However, careful evaluation of the terms and conditions offered by different lenders is crucial to making an informed decision.

Alternative Options for Home Buyers with Bad Credit 

If you're unable to secure a mortgage due to bad credit, there are alternative options worth considering. The most suitable choice depends on the severity of your low credit score. For scores below 600, FHA loans or VA loans may be worth exploring.

Ideally, the best course of action is to focus on improving your credit score before applying for a mortgage. While this may not be the desired solution, it is a practical approach that can save you significant amounts in interest payments. Not only will you have a wider range of mortgage options, but you may also qualify for lower income requirements and down payments.

Here are several options to consider if you're unable to obtain a bad credit mortgage:

Taking steps to improve your score and accelerate its growth can involve increasing your available credit. This can be achieved by paying down balances or requesting credit limit increases. By reducing your credit utilization, a key factor in determining your score, you can raise your creditworthiness. It's important to note that most credit card companies allow multiple credit limit increase requests without triggering a hard credit inquiry.

Adding new accounts not only boosts your available credit but also diversifies your overall credit mix. Opting for a bulk addition of new accounts is advantageous because it consolidates activities within the same timeframe. As a result, inquiries, new accounts, and increased available credit will all align, while contributing to a stronger payment history. Typically, the effects of adding bulk new accounts to your credit report can be observed within 30 to 45 days.

Collections on your credit report can significantly impact your creditworthiness, indicating unpaid debts. While paying off collections results in a "Paid" status, the optimal outcome is to request their deletion entirely. Ensure you obtain written confirmation of the agreement to remove these items from your credit report. Such deletions can improve your credit score, removing one more reason for lenders to decline your application.

Applying for new credit can result in hard inquiries that negatively affect your credit score. While obtaining insurance quotes generally does not impact your score, any application requiring a credit check should be approached cautiously. Avoid initiating actions that involve hard credit inquiries close to the time you plan to apply for a mortgage.

Possibilities for Obtaining a Home Loan with Bad Credit

Don't lose hope if you have bad credit and dream of owning a home. Despite the challenges, homeownership is still within reach with the right approach and thorough exploration of financing options.

Government-backed loans, such as FHA loans, offer a pathway to securing a mortgage even with a credit score as low as 500. While the prospect of buying a home may be enticing, it's crucial to resist the urge for haste and instead invest time in evaluating the various options and interest rates available to you.

Remember, patience and thorough research will lead you to the best solution that aligns with your financial circumstances. Homeownership is indeed possible, even with bad credit.