If you’re paying rent month after month and considering moving up to owning a home, your credit score will be important. But if you’ve been told you have “poor” or “bad” credit it will be hard to get a traditional mortgage loan from banks and lenders. This means owning a home will present some difficulties but there are ways to still make it work.
There are all sorts of factors that go into a low credit score: missed payments, short credit history, job loss, payments in the collection, and more. The hard part is that when you’re labeled with “poor credit” (any score lower than 640), improving it isn’t something that can be done overnight. It takes time, focus, and financial planning to bring your credit score up and if you’re looking to buy a home immediately this could be a major roadblock.
Why is Credit so Important for a Mortgage Approval?
Lenders will always look at more than just your credit score number. Lenders will query one or all of the 3 national credit bureaus (TransUnion, Experian, and Equifax) and receive your entire credit reporting history. This will give them insight into your credit breakdown such as available credit, used credit, payment history, length of credit, and so on.
All of these pieces of information paint a picture of how viable you are as a candidate to not only receive a loan but pay it back. This is what your credit score is really used for, to determine whether or not you will be able to pay back a loan should you be approved for one. Lenders are in this business to make a profit and on large loans like mortgages, they stand to lose a lot if someone defaults on the loan and cannot pay. So having good credit is important to get the loan but also in determining the interest rate you will get.
But in 2020 there are still avenues to receive a mortgage loan even with sub-par credit.
Buying a Home With Bad Credit
A few of these may seem like no brainers but even the most straightforward solutions can produce the outcome you’re looking for. Let’s take a look at the options:
1. Make A Larger Down Payment
Credit can be only a piece of the problem when trying to buy a home. There are other aspects lenders will look at like your income-to-debt ratio for example. Lenders prefer individuals to use no more than 43-44% of their income to pay off current debt they have. This can be a car loan, personal loan, credit card or any other variety of debt you hold on file. If a proposed monthly mortgage payment pushes your debt paying per month over that 44% or is actually more than 43% on it’s own? What then?
To put it simply, start saving money right away to make a larger down payment.
When you make a larger down payment it means that the amount of money you are actually borrowing is less. Therefore the loan amount is less and will lower your monthly payment rate. This is something that can swing the lender towards approval in your favor. It’s a good rule to pay roughly 20% of the home’s price as your down payment. It will improve your chances of getting the loan approval and will also reduce your monthly payment. So this one way to increase your chances of getting a mortgage loan.
2. FHA Mortgages Could Be An Option
In the USA there are more than only privately held banks providing loans, there is also the government you can look towards in some cases. A government Federal House Administration (FHA) loan is backed by the federal government and exists for those needing some assistance when it comes to buying a home.
There are different aspects to a bank loan and a government-backed FHA loan, and the most notable one is the required credit score. While banks will want a credit score of no less than 640, an FHA loan on the other hand requires only a c credit score of 580 or more. The caveat is that you will need to be able to make an initial down payment of no less than 3.5%. This is a solution that can work far more quickly then spending years trying to rebuild your credit little by little.
If your employment history is a problem for a bank lender, an FHA could be an option. FHA lenders look at different factors to make a determination on your “likelihood of maintaining employment”. Where traditional bank lenders will typically require a minimum of 2 years of maintained employment an FHA lender won’t always require this length of time.
3. Borrow From Family or Friends (Privately)
This would undoubtedly be an uncomfortable conversation but it actually is an option that some people use successfully. Family and friends will of course know you more intimately than a bank who only sees a credit report and credit number and who doesn’t know the real you or your situation. By looking to family there are a few benefits.
Usually family will not charge major interest or fees for providing you a loan the way a bank will. It really does depend on your family situation though. Some may be looking to turn a profit on providing you the loan albeit far less than the bank would be looking for. This is something you should be considering. Don’t go into the process expecting your loved one to immediately provide a loan and have no incentive for themselves financially. Let’s say your loved one will provide the loan and would make $10,000 profit when it was paid back. This could be far far less than what a bank would charge in terms of profit.
It’s also a good idea to get a contract or agreement written up and signed so everything is legal. The family will be more willing to provide a loan if they have some assurance that they will be paid back. After all, it is a large sum of money and knowing it will be paid back can be that final piece that lets them confidently provide you a family loan.
4. Use a Co-Signer
If a family member is unable or unwilling to directly provide you with a loan but they do want to help, having them come on as a co-signer could be the best bet. The reason this is positive is that the lender will then look at both of your credit histories and income level. This could push the ticker in your favor as a lender will see there are more resources available and will be more inclined to approve the mortgage loan.
Be sure that whomever you’ll be using has stable employment and a good credit score otherwise it could hurt your changes of getting approval. It’s not all positive for everyone here though. Becoming a co-signer could actually hurt the credit score of the person who is co-signing the loan for you. If you’re unable to pay and the bank defaults into foreclosure this will not just hurt your credit it will also hurt that of your co-signer. The bank can even make collections from both of you. So this is an option to consider but only very carefully and should be done with a financial adviser.
5. Other Mortgage Options
Look at Different Options
If the home you’re looking to buy is just out of your range you can look at a smaller and more affordable home as an option. The loan amount would be less and therefore gives you a better chance for approval. Or you could go with an inexpensive mobile home. For some people and families, this is a perfect fit. You can own your mobile home far more quickly and in a far more affordable way.
Pay in Cash
This may seem absurd but it’s actually an option for some people. If you have some savings or received money from family members will, you could have funds but still, have bad credit. This means paying in cash could be an option for people in different situations.
Get Multiple Loan Offers
By shopping around for different loans you may get approval that you weren’t expecting. It’s always a good idea to get a second opinion for medical advice and the same can be said about mortgages. Places like LendingTree.com have lenders offer you loans and therefore you could find one that fits the bill.
Boost Your Credit Score
This is of course a longer-term option but it’s a fact that the higher your credit the better off you’ll be when it comes to buying a home. It will make lenders more likely to give you a loan at a lower rate and it could also provide you with some time to save up for a larger down payment which will also help your cause.