You can get a mortgage with bad credit. Just ask Scott and Sally Champion, 30-somethings in Dallas, who set a goal of becoming homeowners no later than five years after their marriage.
They met that goal … despite having a credit score of just 600.
The Champions dream seemed to have little or no chance because the numbers simply didn’t add up. Their credit score was a horrendous reminder of their sad financial situation. They had taken positive strides to escape a history of overextending themselves and struggling to make credit card payments.
Still, they had no money — zero — to make a down payment and almost didn’t apply.
Then, guess what? They were approved for a home loan.
No one was more dumbfounded than Scott and Sally. They had virtually none of the criteria that always seemed essential to qualify for a mortgage.
The old rules, they soon learned, have changed so if your credit history isn’t exactly stellar, don’t give up. You may qualify for a bad credit loan.
How Low of a Credit Score Can You Have to Get a Mortgage?
Here are some general parameters for how your credit score affects your ability to qualify for a mortgage:
Below 600 Credit Score
FHA loans are your best bet. They were created by the Federal Housing Administration in 1934 to increase home ownership during the Great Depression. They have been utilized by more than 40 million families to purchase or refinance homes. The loans are insured, so lenders have greatly reduced risk. In 2019, FHA loans made up 15.8% of the market.
For FHA loans, a credit score as low as 580 can be accepted, with just 3.5% in equity. Scores dipping to 550 have been accepted, but a 10% equity position is required (either 10% down when purchasing a home or 10% equity when refinancing). Down payment assistance is non-existent and you will have a difficult time getting approved if your debt-to-income ratio exceeds 45%.
You might be required to show that a financial hardship was the reason you fell behind on your monthly bills, while displaying evidence that you have recovered.
Hopeful note: Nearly 20% of all homebuyers have credit scores below 600.
600-650 Credit Score
This range makes up 20% of all FHA loans. Conventional loans generally have a 620 minimum credit-score requirement. FHA loans allow debt-to-income ratios that exceed 43%, but a credit score of 640 is generally needed to secure the loan. You also could qualify for VA loans and U.S. Department of Agriculture loans. If you have been through a previous short sale, bankruptcy or foreclosure, there could be a waiting period (known as a “seasoning period’’) of two to three years before you can qualify for a mortgage. You might consider a debt consolidation program to help repair your credit score.
650-700 Credit Score
Nearly 40% of the FHA loans fall within this range. You still will be considered a bit of a risk, but you could be able to obtain the conventional loans from Fannie Mae or Freddie Mac. Those are the Congress-created entities that buy mortgages from lenders. By selling the mortgages, lenders use the raised cash for more lending. They can be held or packaged into mortgage-backed securities (MBS) that could be sold.
700-750 Credit Score
Fannie Mae and Freddie Mac loans are much more achievable.
750 and Above Credit Score
Approval should be a formality. The average credit score for Fannie Mae and Freddie Mac approval is 754.
How to Get a Mortgage with Bad Credit
If you have poor credit, here are tips to help qualify for a loan.
Larger Down Payment
Essentially, a down payment reduces risk for the lender. You have skin in the game. They have a buffer. An excellent figure is 20%, which allows you to avoid private mortgage insurance (PMI).
Even with a large down payment, it’s helpful to have ample cash reserves on hand. It will make lenders comfortable that you can absorb the unexpected, such as a failing hot-water heater or a hefty medical expense.
Be able to verify that you’ve paid your rent on time consistently for 12 to 24 months. FICO estimates that less than 1% of credit files contain rental entries, so it pays to investigate alternative credit reporting tools.
They include: Rent Reporters (one-time enrollment fee of $45.95, then $9.95 per month, reports to TransUnion credit bureau); Rental Kharma ($40 setup fee, then $9.95 per month, reports to TransUnion); RentTrack ($2.95 per month, sometimes offered through landlords, reports to all three credit bureaus); ClearNow (debits rent from your checking or saving account, reports to Experian); PayYourRent (variable fees, reports to TransUnion and Experian); ERentPayment ($3 transaction fee for processing electronic rent payments, reports to all three credit bureaus).
If you opt-in to any of these services, here are some follow-up questions: What are the total costs for a year of service? How is my personal data protected? Is there free access to credit scores? How soon will rent information appear on my credit report? How can I cancel the service?
Explain Your Circumstances
It’s helpful to write a letter that explains the borrower’s circumstance while injecting some personality. In today’s world, letter-writing has become a lost art. If your words leap off the page, it’s an advantage.
You should address and account for each negative item on your credit report, even if it seems dated or insignificant. Tell why this problem won’t happen again and what has changed in your life to prevent it.
If there’s a medical issue, get some documentation from the doctor or include the bills. If you were laid off, include a copy of the termination letter or evidence of unemployment benefits. If there was no medical insurance, include proof that you have it now.
Document, document, document.
Should You Take Out a Mortgage or Increase Your Credit Score?
So how badly do you want that house? Or, better yet, how badly do you need that house?
Because if you’ve got some time – at least six months, preferably a year – you can take steps to increase your credit score by 100 points. The first two steps are
- Start making on-time payments every month
- Stop using your credit cards until you paid them all off
Paying on time accounts for 35% of your credit score. Credit utilization – how much of your available credit you use every month – accounts for another 30%.
If you are on time with at least the minimum payment (preferably more) every month and use cash or checks to pay all bills (except in emergencies), you are taking positive steps to address 65% of the factors that determine your credit score.
Is it easy? No, but it’s certainly doable if you really want that house at a payment level you can afford for the next 15-30 years.
Bad Credit Lenders
There are some choices for mortgage loans to consumers with bad credit. It helps to know your options.
Mortgage Brokers vs. Banks/Credit Unions
According to Inside Mortgage Finance, an industry publication, mortgage brokers account for just 9.7% of the origination market. It’s a product of the housing crash, which saw tighter regulations for the industry and banks shifting to more in-house sales operations.
Due to the SAFE Mortgage Licensing Act of 2008, brokers must pass state licensing exams, proving they know the rules of financing. Under federal regulations, brokers aren’t permitted to accept premiums from lenders in exchange for steering customers into higher-priced loans.
Mortgage brokers are middlemen who represent many lenders and various loan products. The broker tries to match the loan product that best meets your needs at the best possible price. Once the loan is approved, borrowers generally deal with the loan originator or their mortgage service provider.
Banks, mortgage banks and credit unions are considered direct lenders. Employees of that institution review your application and decide whether to issue the loan. Typically, banks sell loans on the secondary market a few months after closing.
Benefits of Working with a Mortgage Broker
Mortgage brokers work with many different lenders to find loans for clients, but don’t give loans directly. If you ask a broker what they can offer that a bank can’t, it’s almost certainly going to be summed up in one word — variety.
If a borrower has a low credit score and isn’t certain to obtain a loan, brokers with lots of contacts could find a deal.
Downside? Brokers sometimes attempt to increase their profit by writing hidden costs into your loan. You must be educated about the process and ask questions.
Benefits of a Bank or Credit Union
The best deals can usually be found through a direct lender, simply because there aren’t many add-on fees or middlemen who touch the loan and get paid for it.
Direct lenders are in the volume business, so they can cut costs. Employees usually don’t get a commission, just an hourly rate, so they aren’t looking to create extra charges. They lend out their own money, so cash is made through the servicing of a loan, not through charging origination fees.
If a borrower fits the bank’s criteria — job stability, long-time residence and good income — the loan is practically automatic and follows a rote procedure. Money is made by processing a cookie-cutter type of loan — without extra work or effort.
Downside? Direct lenders offer only their own programs and there’s no comparison shopping and may have higher credit score requirements.
Can I get a mortgage online? Can I be approved for a mortgage online?
The short answer is: Yes!
If you can get groceries, a restaurant meal, a new set of steak knives, a vacation package or holiday gifts online, why not a mortgage?
While searching online, you will see names such as SoFi, Prosper, Lending Tree, Wells Fargo and others that offer mortgage services. Once it was considered risky and questionable. Now it’s mainstream.
“In the beginning, the Internet borrower did it to save money. Now the Internet lenders are not only more competitive in many circumstances, they are also more convenient,” Al Bowman, president of Mortgage Commentary Services in Tampa said. “Who wants to gather pages of documents to go down to a brick and mortar office during business hours when they can accomplish the same thing sitting at a computer at 2 a.m., noon or 11 p.m., if they prefer? They are certainly viable options and should be considered by anyone looking to finance or refinance a home.’’
Shopping Around for a Mortgage
There’s nothing wrong with some comparison shopping between brokers and banks. There might be some excellent online options available as well.
If you’re willing to do some legwork, it’s typical to establish a spreadsheet with three or four mortgage sources, keeping track of interest rates (which change constantly), lock-in fees and points. You also need to know about closing costs, additional fees and whether there is a prepayment penalty.
With brokers, you should ask how they are compensated (it’s usually a percentage of the loan amount, anywhere from 1% to 2.5%) and whether they are paid by the borrower or the lender. Brokers are required to disclose their fees upfront and they can’t earn more than the disclosed amount.
Look for brokers who ask a lot of questions, instead of simply quoting their rates.
Ask friends and family members for suggestions, especially if they recently obtained a loan.
You can check credentials. Mortgage bankers are regulated by either your state’s department of banking or division of real estate. Mortgage brokers, if not regulated by your state, can be checked through the National Association of Mortgage Brokers or the Better Business Bureau.
There are good options online with attractive deals, but make certain you are dealing with a reliable broker or lender.
Which Lender Type is Best for Bad Credit Borrowers?
Mortgage loans aren’t always a one-size-fits-all type of proposition. But here are some general profiles of a borrower, along with the preferred route to a loan.
- Excellent credit, easy access to financial documents, long-time employee of one company: Online lender or bank.
- Self-employed borrower who doesn’t want to share data about income or assets with mortgage provider: Mortgage broker.
- Repeat home shopper, rate-and-term refinance customer, financially savvy: Online lender.
- Adjustable-rate shopper, relationship customer with many accounts and one institution: Bank
- Convenience shopper who wants easiest loan to get, even if it’s more costly: Home builder or real-estate agency lender.
Mortgage Underwriting: Manual or Automatic?
Mortgage underwriting is the process a lender uses to determine whether a borrower is qualified for a loan. It usually follows the “three C’s’’ of underwriting — credit, capacity and collateral.
There are two paths — manual and automatic.
Under manual underwriting, you are assigned a person to review your application. They will review documents such as credit score, debt-to-income ratio, bank statements and pay stubs, then make a decision on your ability to repay. If the underwriter is satisfied, your loan application will be approved.
Under automatic underwriting, it’s a computer-generated decision based on logic and algorithms, thus eliminating human bias. With systems that retrieve relevant data, such as the borrower’s credit history, it gives a near-instantaneous loan approval or denial. Some factors, such as income and assets, must be verified. Occasionally, applications might be referred to manual underwriting, which can require up to 60 days.
Manual or automatic: which is the better choice?
If you have bad credit or a complicated financial situation, the best choice might be manual underwriting. A computerized approval program might quickly decline the application because it focuses on pure data. Manual underwriting is cumbersome and time-consuming, but probably the better option for borrowers who don’t fit a standard mold.
Here are some scenarios that might be quickly rejected by automatic underwriting (thus begging for a manual review):
- Debt-Free Lifestyle: Great credit scores are reflected by a history of borrowing and repaying loans. If you ae just starting out or have no interest costs, your credit evaporates. It’s not bad credit. It’s no That is better interpreted with a human touch because it’s possible to get a loan with no FICO score through manual underwriting. Having no credit is always better than having things like bankruptcy in your credit reports.
- Recent Financial Problems: Manual underwriting provides more loan options after a bankruptcy or foreclosure.
- Low Debt-to-Income Ratios: It’s always a good idea to keep your spending lower than your income. Manual underwriting allows you to go higher, but be careful not to stretch too far and buy an expensive property that could make you “house poor’’ (spending a large portion of your total income on your home and its upkeep).
Know that the approval process probably will be frustrating and monotonous. It’s helpful to identify at least four on-time regular payments you’ve been making for at least the last year. Shop around. Don’t give up after the first negative response. Generally, the idea is to show that the loan won’t be a burden and you can afford to repay.
There are also “compensating factors’’ that will help your application.
- Having liquid assets that cover your mortgage payments for three to six months.
- Having your monthly payment not exceed your current housing expense by the lesser of 5% or $100.
- No discretionary debt.
- Additional income. Automatic underwriting doesn’t count overtime, seasonal earnings and other items that could add to your income. It can be reflected through manual underwriting as long as it’s documented and expected to continue.
There are several advantages to automatic underwriting.
- From application to approval to closing, the process could take as little as two business days to a week.
- Closing costs are reduced.
- Borrowers who weren’t previously approved will be helped by a higher debt to ratio allowance.
- There’s no threat of personal prejudice.
- Loan products can be tailored to the borrower.
The downside? Home loan turnover has tripled. Because the credit score is so important, sometimes the ability of a borrower to repay is overrated and it leads to more defaults that harm the mortgage industry.
Subprime Mortgages: Pros and Cons
Subprime mortgages are loans granted to borrowers with low credit scores (usually below 600), who would otherwise not be approved. Because of the risk assumed by lenders, these mortgages come with high interest rates.
Volatile adjustable rate subprime mortgages — with initial low rates, then a jump to higher figures — were common in the run-up to the real estate meltdown of 2007
Economists blamed them for part of the downturn in the economy. There was a regimented era that followed. Many lenders refused to give a mortgage to anyone with a credit score less than 680.
Everyone’s situation is different, but subprime mortgages come with pros and cons.
- People with low credit scores can own a home without years of trying to establish better credit. That type of activity could stimulate the economy.
- Subprime loans can actually help borrowers fix their credit scores. Borrowers can use it to pay off other debts and then work toward making timely payments on the mortgage.
- It’s relatively easy approval. Borrowers can obtain money, even if they have defaulted on past loans or have outstanding debt.
- Closing costs and fees are higher than normal. Of course, the lender wants as much money up front as possible because there’s a higher risk of default from the borrower.
- Borrowers might not need an average or better credit score, but they must show they have sufficient income to make the monthly mortgage payments.
- Higher interest rates, of course. Good credit could have the borrower qualifying for rates less than 4%. Under a subprime mortgage, it will be more than 8% to 10%. What does that mean? If you have a 30-year mortgage at 4% interest to borrow $100,000, the repayment on normal time will be $171,870. With 10% interest, the repayment balloons to $315,926.
Predatory Mortgage Loans
It’s important to follow your instincts and listen to your gut. If something doesn’t seem right — beware! — you might be dealing with a predatory mortgage loan company.
There are several signs that should serve as a warning that you are headed down a risky path. Realtors or lending officers have done things like inflate closing costs or interest rates; targeted seniors or minorities not familiar with the system; promised to refinance later; or, the worst one, steered you to a specific lender with promises you’ll get the best deal there.
Just know that not everyone has your best interests in mind. Get everything in writing and, if you can’t afford a lawyer, at least have someone you trust look things over before you finalize a deal.
About The Author
Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it seven years ago, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering college and professional sports, which are the fantasy worlds of finance. His work has been published by the Associated Press, New York Times, Washington Post, Chicago Tribune, Sports Illustrated and Sporting News, among others. His interest in sports has waned some, but his interest in never reaching for his wallet is as passionate as ever. Bill can be reached at email@example.com.
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