Getting a Mortgage With Bad Credit

Purchasing a home often requires taking out a mortgage, which can be challenging for borrowers with lower credit scores. While lenders prefer borrowers with excellent credit, options exist even if your credit is less than ideal. This guide will explain techniques to qualify for a mortgage when you have bad credit.

We’ll cover Federal Housing Administration (FHA) loans, improving your credit, finding specialized lenders, down payment requirements, and steps to rebuild your financial profile to become an attractive borrower. With diligence and perseverance, home ownership is achievable despite past credit mishaps.

Why Credit Scores Matter for Mortgages

When you apply for a home mortgage, lenders scrutinize your credit profile carefully. Borrowers with higher scores get the best rates for several reasons:

Reflects financial responsibility – Higher scores indicate reliably paying debts which reduces perceived risk of default.

Determines minimum down payment – Conventional mortgages require larger down payments for lower credit applicants. Excellent credit needs as little as 3% down.

Influences interest rates – Every 10-point increment in credit scores can save 0.1% or more on mortgage interest rates. Just a 0.5% rate difference on a $250,000 mortgage saves $30,000+ over 30 years.

Impacts loan approval – Low scores make lenders less likely to approve mortgages at all, seeing applicants as too high risk.

So while creditworthiness is not the only factor, it significantly impacts mortgage terms offered and eligibility. Raising your score before applying saves substantially.

What Credit Score is Considered Bad?

Credit scores range from 300 to 850. General ranges determining bad versus good credit include:

Poor – Scores below 580
Fair – Scores 580 to 669
Good – Scores 670 to 739
Very good – Scores 740 to 799
Exceptional – Scores 800+

Many lenders view scores under 620 or so as poor credit. This makes approval difficult and raises rates. Boosting your score to 620+ expands possibilities. Excellent credit over 740 gets the best deals.

Specialized Lending Programs for Bad Credit

The Federal Housing Administration (FHA) offers a key mortgage program assisting borrowers with weaker credit:

FHA Loans

Requires just 500+ score with 10% down (580+ with 3.5% down)
Government insured so approves lower credit applicants
Offers fixed rates and terms up to 30 years
Allows gifts and grants for down payment assistance
Requires mortgage insurance adding to monthly costs

FHA loans provide more flexible underwriting and down payment options for those unable to qualify through conventional lenders. Government backing makes them appealing to lower credit borrowers.

Using FHA Loans with Bad Credit

Besides more lenient credit approval, FHA loans offer additional advantages:

Competitive Rates

FHA rates often compete favorably with conventional loans, especially for borrowers with poor credit.

Lower Down Payment

Just 3.5% down required rather than up to 20% for conventional mortgages.

Flexible Guidelines

Prior bankruptcy or foreclosure is allowed if sufficient time has passed. Gift funds can be used for down payment.

Upfront Mortgage Insurance

Mortgage insurance costs can be financed into loan rather than required monthly.

For those with scores as low as 580 and enough savings for just 3.5% down, FHA loans make home ownership feasible where conventional loans would deny or charge exorbitant rates.

Improving Your Credit Score Quickly

Even marginal score improvements may help mortgage approval chances and interest rates. Options to raise your credit score in the short term include:

Correct errors on credit reports – Dispute and fix mistakes dragging down your score.

Pay down balances – Lower credit utilization by paying down balances, especially on revolving credit.

Avoid new credit inquiries – Each application causes a short-term dip in scores.

Become an authorized user – Get added as authorized user on someone else’s older account to benefit from positive history.

Pay down tax liens – Settle overdue IRS obligations that hurt your credit report and score.

Consolidate debt – Reduce overall utilization by consolidating balances under a new lower-rate loan.

While long-term credit rebuilding takes time, even 50-100 point gains quickly can help mortgage approval odds for those with low scores.

Alternate Options for Bad Credit Mortgage Seekers

Beyond FHA loans, those struggling to get a mortgage have some alternatives:

VA Loans – For veterans and service members, VA home loans require no down payment or minimum credit score. Offers competitive fixed rates like FHA loans. Increased paperwork and eligibility rules apply.

USDA Loans – For properties in rural areas, USDA-backed mortgages require no down payment and flexible credit standards like FHA loans. Must meet income limits and home value thresholds.

Subprime Lenders – Specialty lenders like non-bank mortgage companies may approve borrowers with scores as low as 500, but impose higher rates and large down payments. Shop carefully.

Hard money loans – Lenders specializing in real estate investment offer short term loans for those unable to qualify elsewhere, but impose high rates and require collateral.

Owner financing – Some sellers provide their own in-house financing with more flexible terms for those unable to obtain bank financing. Higher rates and large down payments common. Know your rights.

Credit union financing – Member-owned credit unions may offer exceptions from common lending standards for members withexplained past credit challenges.

10 Tips for Getting a Mortgage with Bad Credit

Those with less-than-ideal credit can still achieve home ownership by:

Boosting credit score over 620+ where possible.
Saving for larger 10-20% down payments required.
Focusing on FHA, VA, and USDA loans requiring just 500+ scores.
Finding specialized subprime lenders willing to work with bad credit.
Asking sellers about owner financing when credit is an obstacle.
Having a stable income history and clean recent credit profile.
Using verifiable gift funds if able to make mortgage payments comfortably.
Considering a manual underwriting exception where strong compensating factors exist.
Providing thorough explanation of past credit issues and rebuilding efforts.
Applying with a stronger co-borrower if possible.

While challenging, with a credible explanation for past issues, recent clean credit, and sizable down payment, mortgage approval is possible even with poor previous credit.

Long-Term Credit Rebuilding Tips

Reestablishing strong credit takes years of diligent habits, but lenders reward your efforts. Maximize score improvement by:

Making all payments on time each month
Keeping balances below 30% of credit limits
Mixing types of credit – mortgage, credit cards, auto, etc
Limiting credit applications while rebuilding
Settling collections accounts and tax liens
Leaving old accounts open after rebuilding to maintain aging
Monitoring credit reports and disputing any errors
Asking for credit limit increases over time to lower utilization

With determination and smart financial moves, even deep credit damage can be reversed to achieve scores above 700 within a few years.

Down Payment Options with Bad Credit

Those with poor credit scores typically must compensate with larger down payments. While FHA loans allow just 3.5% down, many conventional lenders require 10-20% down for borrowers with scores below 620.

If lacking funds for sufficient down payment, options include:

Asking seller for down payment assistance or to finance a second mortgage
Borrowing from 401(k) or IRA retirement plans if permitted
Tapping home equity via cash-out refinance if you already own a home
Utilizing gift funds from relatives with documentation
Applying for down payment assistance grants and programs
Taking a personal loan, cash-out home equity loan, or cash-out refinance
Liquidating investments like stocks to cash

While requiring short-term sacrifices, larger down payments secure approval. Determine the most affordable sources available to reach at least 10% down if possible.

Why Large Down Payments Matter

Putting down more upfront provides multiple benefits:

Shows greater borrower commitment
Lowers loan-to-value ratios for lender safety
Reduces monthly mortgage payments
Allows qualifying for lower mortgage rates
Provides equity cushion protecting against foreclosure if values drop
Eliminates need for private mortgage insurance (PMI)

While mortgage qualifying with poor credit is still feasible with minimal 3% or 5% down, much more favorable terms and rates incentivize larger down payments from lower credit applicants.

Using Retirement Funds for Down Payment

Tapping tax-deferred retirement accounts lets you access larger down payments quickly but isn’t ideal long-term:

401(k) Loan

Borrow up to 50% of 401(k) balance or $50,000
Typically pay yourself back with interest over 5 years
Requires steady repayment to avoid taxes/penalties

Early 401(k) Withdrawal

Allowed if leaving job after age 55
Withdrawals taxed as income plus 10% penalty

IRA Withdrawal

Can withdraw contributions tax-free any time
Tax/penalty on earnings if under age 59.5

Try to avoid early withdrawals or borrowing against retirement accounts which sacrifice long-term growth. But during mortgage hurdles, they provide a means to the short-term goal of home ownership if used prudently.

Talking to Mortgage Lenders About Bad Credit

If your credit score is under 620, don’t hide your history when talking to lenders. Proactively explain any past issues. Key steps include:

Pull your full credit reports so you know what the lender will see. Look for errors to dispute before applying.
Research credit scoring models so you understand why your score is low and any key factors dragging it down.
Create your credit story – what caused prior financial issues, how you’ve managed credit since, and steps taken to rebuild your profile over recent years.
Gather documentation showing your income stability, clean recent payments, and improved credit like higher scores or limits.
Be prepared to provide larger down payments and non-borrower co-signers as needed.

Don’t make excuses or blame others. Take responsibility for past mistakes, demonstrate you’ve changed course, highlight recent progress, and show how you will be successful moving forward. This reassures apprehensive lenders.

Refinancing into a Better Mortgage after Improving Credit

The mortgage you qualify for when first buying with poor credit likely carries a higher interest rate and less favorable terms. Once you’ve improved your financial profile after a few years, refinancing into a new mortgage potentially saves:

Lower interest rate saves monthly and overall lifetime costs
Shorter repayment term builds equity faster
Lower or remove mortgage insurance premiums
Access cash-out to consolidate other debts or finance projects
Potentially switch from FHA to more flexible conventional loan

Refinancing makes sense once you gain at least 50 to 75 points on your credit score and the savings outweigh closing costs. Having established home equity also helps qualify for the best new loan terms.

Common First-Time Home Buyer Programs and Down Payment Assistance

Several programs help first-time buyers struggling with down payments and credit challenges:

FHA loans – Require just 3.5% down for those with 580+ credit scores. MIP insurance is required.

VA loans – No down payment needed and more flexible underwriting for veterans. Funding fee applies.

USDA loans – 100% financing options in rural areas for low/moderate income buyers.

Down payment assistance programs – State and local groups offer grants and low cost loans to cover down payments and closing costs.

Seller incentives – Sellers may agree to “buy down” interest rates or cover closing costs to attract buyers.

Gift funds – Relatives often gift money toward the buyer’s down payment with proper documentation.

Community land trusts – Offer homes at lower prices with more flexible financing in exchange for resale restrictions to keep affordable long-term.

Check if any federal, state, local, nonprofit, or employer programs exist that provide assistance tailored to your circumstances.

Why a Higher Credit Score on Mortgage Applications Gets Approved

Higher credit scores signal to mortgage lenders that applicants represent lower risk and greater ability to reliably make payments over decades. Key factors leading to approving borrowers with excellent credit include:

Proven willingness – Higher scores prove a long history of responsibly managing diverse credit accounts and financial obligations. This shows discipline to handle a mortgage properly long-term.

Increased dependability – Data-driven algorithms predict higher credit borrowers are statistically less likely to default based on performance history.

Reduced risk – With high scores, even job loss or hardship is less likely to turn into a mortgage default. Borrowers have additional financial cushion.

Higher equity – Good credit allows lower down payments. More equity invested upfront gives buffer against declining home values reducing chance of “underwater” mortgages.

Lower interest rates – A lower rate saves thousands over the life of the mortgage, increasing affordability and reducing payment burdens.

At the end of the day, lenders want borrowers least likely to default. Applicants with demonstrated financial responsibility reflected in credit scores get approved faster and with better terms.
For borrowers yet to establish strong credit, taking prudent steps to continually build your profile leads to better mortgage outcomes down the road. But options exist even when starting with less-than-ideal credit if you know where to look and how to improve your financial standing over time.