Did you know that the average FICO (Fair Isaac Corporation) credit score in the U.S. reached 716 in April 2021? That shows an impressive increase of 8 points from April 2020. For reference, FICO scores range from 300 to 850, and most home loan lenders use them to qualify borrowers. However, only 67% of U.S. consumers have good to exceptional scores (670 and above). The rest have fair or poor (AKA bad) scores. Securing a home loan with bad credit is much more difficult, but it’s still possible.
Below, we’ve shared tips on how to get a loan to buy a house even with poor credit, so please read on.
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Understand and Boost Your Credit Score First
FICO scores between 670 and 739 fall in the “good” category. Very good scores are from 740 and 799, and those above that, up to 850, are exceptional. On the other hand, scores between 580 and 699 are fair, while anything below 580 is already poor. While there’s no set minimum credit score to get a mortgage, many lenders consider 620 the lowest. So if yours is 619 or below, lenders may already deem you too high risk and, thus, reject your application. Even if they approve it, they’ll likely charge you a much higher annual percentage rate (APR).
As shown by data from FICO, the lower a credit score, the higher the applied mortgage APR. For example, borrowers with a score of 760 to 850 and taking out a $300,000 loan may only get charged a 6.084% APR. By contrast, those with scores between 62 and 639 may face a 7.673% APR.
That’s thousands of dollars of difference over the life of a long-term mortgage.
So if you can afford to wait, consider boosting your low credit score first. One way to do so is to pay down existing loans or credit card balances to improve your debt-to-income (DTI) ratio. For the same reason, avoid taking on new credit.
Ensure Your Credit Report is Error-Free
Your credit report summarizes your credit history. For example, it lists your credit card accounts, loan statuses, delinquencies, or foreclosures. Your credit report differs from your credit score but still impacts each other. For example, several reported delinquencies can lower your credit score.
The problem is that some of the negative items listed in your report may be erroneous. Even worse is that such incidents are common; 1 in 3 Americans has had errors in their credit reports. If you’re one of them, your score may have dipped due to these mistakes.
So before applying for a home loan, or any other kind of loan, for that matter, check your credit report first. You can get a weekly copy for free through the three major credit reporting bureaus. Equifax, Experian, and TransUnion offer these free weekly copies throughout 2023.
Once you get your copy, please review it and ensure there aren’t any mistakes. If there are, dispute them with the reporting agency.
Get a Home Loan for Bad Credit Borrowers
If you can’t wait to buy your first home, consider applying for a bad credit mortgage. These include government-backed housing loans, online and non-bank mortgages, and hard money loans. Most have lower credit and down payment requirements.
FHA (Federal Housing Administration) Loans
FHA loans are available for low- to moderate-income home buyers. They’re also ideal for those with credit scores as low as 500, although some FHA lenders require at least 580. If your credit score is 580 or higher, you can make a minimum down payment of 3.5%. For example, if the home you want to buy sells for $250,000, your down payment must be at least $8,750.
If your score is below 580, you might have to make a minimum 10% down payment. So for a house priced at $250,000, prepare to put down at least $25,000.
VA (Veterans Affairs) Loans
VA loans don’t have minimum credit score thresholds, but some VA lenders may require at least 580.
Unlike FHA loans, you don’t have to pay a mortgage insurance premium (MIP) with VA loans. However, only veterans, active service members, and surviving spouses can get VA loans.
Online and Non-Bank Loans
Online and non-bank lenders often specialize in providing bad credit mortgage offers. They have lower credit requirements, approving borrowers with scores as low as 500. The downside is that they charge higher interest rates than banks.
What if you have an existing mortgage but would like to buy and take advantage of a low-priced house? If so, one of your options is a hard money second mortgage, also called 2nd position hard money loan. With this, you can use your equity in your first home as collateral for the new loan.
Since a hard money second mortgage is a type of secured loan, it has a lower credit requirement. Therefore, you can qualify for one even with your bad credit score.
Seek Help from a Co-Signer
A co-signer takes full responsibility for paying back a loan if the primary borrower can’t. It’s their legal obligation to repay any missed mortgage payment or even the entire loan. Thus, most co-signers are family members, such as the parents or siblings of a primary borrower. With a co-signer, you can give lenders extra assurance that they can get their money back. They look at this as someone “picking up” your tab if you can’t pay your dues.
That can help boost your chances of securing a home loan. However, that’s only true if your co-signer has a good to exceptional credit score.
Also, remember that if you miss a payment, your co-signer’s creditworthiness also drops. Therefore, please ensure you always make your payments on time. Otherwise, both of you will suffer the consequences of having bad credit.
Time to Get a Home Loan with Bad Credit
As you’ve learned in this guide, qualifying for a home loan with bad credit is possible. However, it’s still best to boost your score first, as the higher it is, the better your odds of getting approved. But if you can’t wait, consider applying for a loan with lower credit requirements, such as an FHA or a VA loan.
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