Bad-credit home loans attract borrowers with a sense they can buy into a house and find a way to make it work after a rate increase happens, or refinance, but if you cannot make it work, you could end up losing the home and hurting your credit even more. While many mortgage lenders will not give loans to people with poor credit, there are lenders who will actually give loans to someone with lower scores.
While the specific requirements of a mortgage differ from lender to lender and from loan program to loan program, having bad credit when it comes to a mortgage usually means having a score close to the lowest allowed for the specific loan. A poor credit score for mortgages is a score that does not qualify you for the loan, allows only a higher-cost loan, or requires a larger down payment in order to qualify.
Because applying for a mortgage with poor credit can mean you qualify only for a loan that could be hard to repay, it might be wise to hold off on buying a house until your credit score improves. If your credit is poor because you did not understand how to handle credit, but have learned since; because you went through a bad patch, but are doing well now; or because divorce or identity theft have destroyed your credit, you might feel comfortable buying a house now if you are able to qualify for a loan regardless of your credit.
There is not any credit score threshold that absolutely locks you out of getting a mortgage, but the lower your score, the harder it is to find a lender that will underwrite your loan. Credit scores of mid-600s or lower can make it harder to qualify for a loan, and these borrowers typically need to pay a much higher interest rate, meaning that the loan is going to end up being more expensive. Buyers with credit scores at least 640 may qualify for a loan through a lender, but a minimum credit score is not required for loans taken directly from USDA, and there is no down payment required for either type. No down payment is required for USDA loans, interest rates are typically lower than you would pay for a traditional loan, and it is possible to qualify with even a less than perfect credit.
USDA loans are popular because of the zero down payment requirements and lower rates. Government-backed loans have fewer strict requirements and lower down payments than many conventional mortgages. If you are looking for one of these loans, look at special mortgage programs that some banks are offering that are not either a conventional or a government-backed loan. One common type of loan that is available to people with bad credit is the government-backed loan.
While some lenders will give traditional loans to borrowers with poor credit, you will usually receive more affordable financing if you obtain a government-backed mortgage loan. While buyers with perfect credit qualify for mortgages with the most favorable terms, there are a number of programs and loans out there for would-be homeowners buying homes with poor credit. Borrowers with fair to excellent credit have the most loan options. Home Possible loans are also targeted at buyers with no credit history, but require a 5% down payment, as well as private mortgage insurance, for down payments of less than 20%.
To qualify for Home Possible loans, which have lowered private mortgage insurance (PMI) rates, most lenders will require a 620 or better credit score. To compensate for the risks that lower-credit borrowers may incur, FHA loans require mortgage insurance payments (MIPs).
Some lenders can make an FHA loan available to borrowers who score at least 500, or to those who do not have a score but are able to establish nontraditional credit, a loan for 10% down. For borrowers with a score of at least 500, there are a few loan options, Federal Housing Administration loans and VA loans, specifically, that are available, and they might not be so hard to get. FHA loans let borrowers with as little as 3.5% down pay qualify for home loans, provided they have a credit score of 580 or higher. A federal housing administration, or FHA, loan generally allows you to buy a house with looser requirements–for instance, you can be approved with a lower credit score, or be allowed to get away with having a higher debt-to-income ratio.
Similar to its own loan program, the VA guarantees a portion of a loan, making it less risky for lenders to approve mortgages for qualifying members, even if they have lower credit scores. While these loans are underwritten and issued by approved lenders, they are still guaranteed by the U.S. Because these home loans are designed to help qualifying borrowers speed up the road to homeownership, they are also subject to fewer strict requirements.
Some home loans are designed specifically to help lower-credit applicants qualify for homes. The mortgage is for borrowers with low to moderate incomes living in designated rural areas, usually by population size. Federal Housing Administration loans are designed for borrowers with lower credit scores and down payments, who might be unable to qualify for conventional loans.
Other requirements for qualifying for FHA loans include having steady income, evidence of employment, and having a debt-to-income ratio of 43% or lower (that is, how much of your monthly income goes to debt), though some lenders will accept a DTI of up to 50%. You can qualify for a mortgage with a USDA-backed loan with a score of just 600, but you will have to undergo a manual underwriting process which will ask to see your finances in greater detail.
Subprime mortgages–loans offered to borrowers with lower credit scores with an interest rate higher than the prime rate–are another example of nonconforming loans, but they have been less common since the 2008 housing bust. There are lenders who do offer conforming loans to borrowers with poor credit, but you might find these come with higher rates, higher fees, and higher down-payment requirements. Look for programs widely used by first-time homebuyers with poor credit, like FHA mortgages (as little as 3.5% down), VA financing (zero down), USDA mortgages (zero down), Fannie Mae HomeReady mortgages (3%) and Freddie Mac Home Possible loans (3%).