Mortgage 101

How to Get a Bad Credit Home Loan

Published on: May 20, 2021

Borrowers looking for a bad credit home loan may have fallen on hard times or are struggling to improve their credit score. Even if you have a bad or insufficient credit history, you still have mortgage options through government-backed loans or non-qualified mortgage programs.

Learn the ins and outs of how to apply for a mortgage with bad credit and tips on how to improve your odds of qualifying for these types of loans.

Can you buy a house with bad credit?

Financing a home with bad credit is possible, however, you’ll probably need to jump through some hoops to do so. Getting a mortgage with bad credit means you’ll likely pay higher interest rates, private mortgage insurance (PMI) or a higher down payment amount.

Before you start shopping for a home, find out what your credit score is and obtain a copy of your credit report. Anyone can obtain a free copy of their credit report from each of the three national credit reporting companies at AnnualCreditReport.com.

Many credit card companies and banks provide access to your credit score for free. Alternatively, go straight to the source by ordering a credit score report from any of the credit reporting agencies: Experian, TransUnion and Equifax.

Once you know where your credit score stands, you can whittle down your loan options and shop for mortgage lenders.

What do mortgage lenders consider a low credit score?

According to Experian, a FICO credit score below 669 is considered low, or “subprime.” However, the minimum credit score requirement for most mortgage programs is 620.

FICO Score Ranges Rating
<580 Poor
580–669 Fair
670–739 Good
740–799 Very good
800+ Exceptional

Even if your score is below the 580 , you could still qualify for some government-backed loans and non-qualified mortgages with other mitigating factors, like a higher down payment amount, mortgage payment reserves and a low debt-to-income ratio.

Compare 5 home loans for bad credit

You still have some options when it comes to picking a mortgage with a bad credit score. While not an extensive selection, a little bit of research may save you a lot of money when it comes to qualifying for a home loan with bad credit. Consider comparing the mortgage loans below based on your situation.

Loan Minimum credit score Minimum down payment Requirements
FHA loan 580 (with 3.5% down)

500-579 (with 10% down)

3.5% (with 580+ FICO)

10% (with 500-579 FICO)

Must pay an upfront mortgage insurance premium (UFMIP) and annual MIP for the life of loan
VA loan None set by VA, but many lenders prefer 620 0% Active-duty military service members, veterans and eligible spouses only
USDA loan None set by USDA, but many lenders prefer 640 0% USDA-approved rural properties only
Fannie Mae HomeReady 620 (or alternative data) 3% Income doesn’t exceed 80% of area median
Freddie Mac Home Possible 660 (or alternative data) 3% Income doesn’t exceed 80% of area median

* Terms may vary from lender to lender based on different borrowing requirements

FHA loans

Minimum credit score required: 500 -579 with 10% down; 580 with 3.5% down

Pros: Low credit score requirements

Cons: Mortgage insurance required for life of loan

FHA loans are insured by the Federal Housing Administration (FHA) and have the lowest credit requirements of all government-backed mortgages. An added bonus: FHA loans don’t have special qualifying requirements as other government-backed loans do. The minimum credit score for an FHA home loan is 500 with a down payment of 10% or more, while those with a score of 580 or higher level can put as little as 3.5% down.

FHA loans also have reduced waiting times for borrowers to qualify for a home loan after a major credit event, such as a bankruptcy or foreclosure.

FHA loans require both upfront and annual mortgage insurance premiums (MIP) for the life of the loan, which tacks on additional costs. While an FHA loan can get your foot in the homeownership door, you might consider a mortgage refinance after you’ve had a few years to build up your credit score.

VA loans

Minimum credit score required by many VA lenders: 620

Pros: No down payment required

Cons: Limited to military borrowers only

VA loans are backed by the U.S. Department of Veterans Affairs (VA) and are offered to eligible active-duty service members, veterans, and their spouses. While VA loans carry no explicit minimum credit score requirement, many lenders set their own FICO score minimums, typically starting at 620.

VA borrowers aren’t required to make a down payment and can finance 100% of the loan amount. VA loans also don’t require mortgage insurance, regardless of how little you decide to put down.

VA borrowers must pay a VA funding fee, which helps offset the cost of the VA loan program to taxpayers. The funding fee is generally a small percentage of the loan amount, and borrowers can either pay it at closing or roll it into their loan balance. Some borrowers may be exempt from paying the funding fee if they have a service-related disability.

USDA loans

Minimum credit score required by many USDA lenders: 640

Pros: 0% down payment

Cons: Limited to USDA-approved rural areas

USDA loans are guaranteed by the U.S. Department of Agriculture (USDA) to help encourage homeownership in rural areas of the country. To qualify, you must buy a home in a USDA-approved rural area. While the USDA doesn’t set a minimum credit score requirement, mortgage lenders typically prefer a minimum FICO scores of 640.

USDA loans allow qualified applicants to purchase a home with 0% down and carry attractive rates relative to FHA loans and conventional mortgages. To obtain the best rates, you’ll likely need to contribute a larger down payment.

USDA loans are backed by the U.S. Department of Agriculture (USDA). Qualifying rural and suburban areas are eligible generally based on a location’s population size. Check the USDA’s website to confirm whether the area you’re interested is a USDA-approved rural area.

To qualify as a borrower, your monthly income also cannot exceed 15% above the median average for your target market. The USDA also charges its own upfront and annual mortgage insurance fees.

Fannie Mae HomeReady®

Minimum credit score required: 620

Pros: Down payment as low as 3%

Cons: Must earn less than 80% of the local area median income to qualify

Fannie Mae HomeReady® mortgage loans are an attractive option for borrowers with bad or no credit. To qualify for a HomeReady mortgage, you typically need a minimum credit score of 620, however, many lenders can use manual underwriting based on alternative credit data, such as your rental payment history.

One of the advantages of Fannie Mae HomeReady mortgages over Freddie Mac Home Possible is that HomeReady allows you to count income from non-borrower household members towards your debt-to-income ratio. Additionally, borrowers can pay as little as 3% on their down payment.

Because HomeReady is a Fannie Mae program, you’ll still be required to pay PMI if you make less than a 20% down payment at closing.

Freddie Mac Home Possible®

Minimum credit score required: 660

Pros: Allows alternative underwriting for borrowers with no credit

Cons: Must earn less than 80% of the local area median income to qualify

Freddie Mac Home Possible® mortgages were created with low- to moderate-income borrowers in mind. You typically need a minimum credit score of 660 to be eligible. That said, prospective homebuyers who don’t have an established credit score can use alternative credit data such as payment references and rental payment history in lieu of a traditional credit score.

If you apply without a credit score, though, expect a higher down payment of 5%. Qualifying borrowers with a FICO score of 660 or more can put down just 3%.

Freddie Mac Home Possible mortgages still require PMI for down payments of less than 20%. To be eligible, your income cannot exceed 80% of your local area median income.

How to apply for a mortgage with bad credit

If you’re trying to apply for a mortgage with bad credit, you’ll need to increase the size of your down payment, pay down outstanding debt, and seriously consider improving your credit score. However, your credit score isn’t the only thing that mortgage lenders will consider. Other items they evaluate include:

  • Loan-to-value ratio: How much you intend to contribute towards your down payment relative to the overall cost of the home
  • Debt-to-income ratio: Size of your monthly debt payments in relation to your gross monthly income (before taxes)
  • Cash reserves: How much money you have in liquid assets to pay mortgage payments if you experience an income disruption

Some mortgage lenders may be flexible about a bad credit score if you pose less risk on these other factors. Lenders need to ensure that you can afford your current mortgage payment and that you can repay it for the long haul.

Here are some steps you can take to raise your chances of qualifying for a mortgage with bad credit.

Reduce your loan-to-value (LTV) ratio

If you increase the size of your down payment, your loan amount is lower and the lender takes on less risk. This can help you better qualify for a mortgage and might even result in a more competitive mortgage rate.

Contributing more of your savings, inheritance money or donor gift money may increase your odds of qualifying for a mortgage with bad credit. However, keep in mind that some lenders will require you to document the source of the funds for your , especially if it’s coming from a gift from a relative or friend.

Lower your debt-to-income (DTI) ratio

There are two ways to attack your debt-to-income ratio: 1) reduce the amount of outstanding debt you have or 2) increase your income.

Pay off any outstanding loans in full, if possible. Once these accounts are paid off, the required monthly payments can be taken off the books, thereby reducing your DTI ratio.

While easier said than done, increasing your monthly income can also reduce your DTI ratio and shows that you’re able to repay your monthly mortgage obligation. Lenders usually require you to provide two years’ worth of documentable income when calculating your DTI ratio. The more you can boost your income, the lower your DTI ratio will be.

Lower your credit utilization ratio

Revolving credit pertains mainly to credit lines, like credit cards and home equity lines of credit (HELOCs). While having a revolving credit line open can help your credit score, using too much of your available limit on each account might ding your credit score.

Pay down your outstanding credit card balances and other revolving accounts as possible. This reduces your credit utilization ratio, which is how much you owe in relation to the maximum credit limits on your revolving credit accounts. This ratio plays a crucial role in your credit score calculation.

Ask your credit card company to increase your credit limit. Avoid opening (or closing) credit accounts, which can impact your credit score, too.

Double-check your credit report and dispute errors

Reviewing your credit report and asking the credit bureaus to remedy any inaccuracies is one of the fastest ways to improve your credit score. It’s also generally a good idea check your credit report each year and dispute any errors or suspicious activity. This is especially important if you’re planning to apply for mortgage.

Request a free copy of your credit report each year from AnnualCreditReport.com. You’re entitled to one free copy of your credit report from each of the major credit bureaus every year.

Should you get a bad credit home loan or wait?

It pays to wait a few months and improve your credit score before committing to a bad credit mortgage loan. The main reason: You’ll usually snag a lower interest rate with higher credit scores.

According to MyFICO, the national average mortgage rate for credit scores between 620 and 639 was more than 160 basis points higher than mortgage rates for comparable home loans with credit scores in the 760 to 820 range. On a $200,000 home loan with a 20% down payment, that adds up to more than $50,000 in extra interest costs over the life of a typical 30-year mortgage.

Tack on added charges like funding fees and PMI, which are required for certain bad credit home loans, and you might be biting off more than you can chew.

Avoid applying for a mortgage with bad credit if you can wait. Having a long and responsible history of on-time account payments is the biggest factor in improving your chances of getting a mortgage On-time payments make up about one-third of your FICO score calculation.

The difference of an extra few months or even years to get your financial house in order isn’t going to make or break your plans. Consider responsibly paying off your debts and building up your savings so that you can qualify for a much more competitive mortgage rate in the future.

FAQs for financing a home with bad credit

How do I find the right mortgage lender for bad credit?
The market for mortgage lenders runs the gamut from banks to credit unions to online lenders. Each mortgage lender has its own tolerance for bad credit. For example, national banks sometimes have restrictions preventing them from taking on bad credit home loans for regulatory reasons.

Credit unions may be more willing to work with you if you have a low credit score. Alternatively, mortgage brokers, or agents who specialize in finding mortgages, may know where to look for a bad credit home loan that fits your needs. Keep in mind that mortgage brokers are likely to cost more in commission or higher interest rates if they able to successfully find you a loan.

Will getting a bad credit home loan make my loan more expensive?
Yes, bad credit home loans are more expensive than comparable home loans for borrowers with good or excellent credit. Bad credit home loans are typically quoted mortgage rates that are higher than rates on comparable home loans for borrowers with excellent credit, according to MyFICO.com. These charges can add up to tens of thousands of dollars in added interest expenses over the life of a loan.

Should I get a mortgage co-signer?
Getting a co-signer for a bad credit mortgage can improve your odds of qualifying for a loan if your co-signer has stronger credit or income qualifications. It can strengthen your application when it comes to getting approved and may even improve the mortgage rate you’re quoted.

Co-signing a mortgage is a legal responsibility, and your co-signer will end up being on the hook for your mortgage payments if you end up defaulting. Additionally, a co-signer on a mortgage is different from a co-borrower; co-signers don’t enjoy the same rights to the home as a co-borrowing applicant.

Asking someone to co-sign your home loan is a big ask that can have major implications for both your finances and relationship. Make sure that both you and your co-signer are aware of all the risks before moving forward.

Can I refinance a bad credit home loan?
Yes, you can refinance a bad credit home loan, but you’ll need to qualify for a new loan to replace your existing mortgage, including undergoing a new credit check. Work on improving your credit score well in advance of applying for a mortgage refinance to maximize your chances of securing the best mortgage rate and terms.

Work with a mortgage lender to figure out whether it even makes sense to refinance your mortgage. This largely depends on the current interest rate environment and terms of your original mortgage. Refinancing a mortgage might lower your mortgage payments if you previously took out a bad credit home loan at a higher interest rate, or if your original loan has steep PMI payments.

Contact a FAM Loan Advisor today who can help you find the right loan product to meet your needs.

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