Getting Home Loans for Bad Credit

When pursuing homeownership, a blemished credit history can be a daunting hurdle. However, your dreams are far from over. Home loans for bad credit do exist. This guide will outline your options and provide some practical advice.

What Are Home Loans for Bad Credit?

Bad credit home loans are mortgage options designed for individuals with low credit scores. These loans offer opportunities for homeownership despite credit challenges. 

Credit score classifications are important. Scores range from 300 to 850, with 580-669 considered fair and 300-579 considered poor. When lenders refer to bad credit, they often mean a score near the minimum allowed for a specific loan program or a history of financial mishaps, such as multiple late payments or bankruptcy.

Your credit score is a risk assessment tool. While lenders evaluate the overall financial situation, your score weighs heavily because it reflects your financial habits. Understanding your credit score's impact is a crucial step towards homeownership.

What Are the Best Loans for Homebuyers With Bad Credit?

There's good news for potential homebuyers with fair or poor credit ratings. Despite the higher score requirements for traditional mortgages, several programs offer home loans for bad credit.

FHA Loans

Federal Housing Administration (FHA) loans can be an advantageous route for those dealing with lower credit scores. This government-insured loan program provides borrowers with a comparatively lenient credit requirement. Buyers can qualify with a credit score as low as 500, but this requires a 10% down payment.

However, if you can achieve a credit score of 580 or above, the required down payment drops to just 3.5%. Furthermore, FHA loans tend to have shorter waiting periods after significant credit issues, such as bankruptcies or foreclosures, when compared to conventional loans. However, to balance the risk, these loans usually come with two types of mortgage insurance premiums.

VA Loans

VA home loans, backed by the U.S. Department of Veterans Affairs, are primarily for active-duty service members, veterans, and their eligible spouses. A distinguishing feature of these loans, which are also a viable option for home loans for bad credit, is the absence of a down payment requirement.

While there's technically no minimum credit score for VA loans, most lenders usually look for a score of 620 or higher. It's worth noting that VA loans come with a funding fee, a percentage of the loan amount that can be paid upfront at closing or rolled into the loan itself.

USDA Loans

USDA home loans are backed by the U.S. Department of Agriculture and are intended to help low- and moderate-income individuals in rural areas achieve homeownership. Although rural might seem limiting, the USDA's definition is surprisingly broad, including many suburbs and outlying towns.

Fannie Mae HomeReady®, and Freddie Mac Home Possible® Loans

Two more options for buyers with lower credit scores or unconventional credit histories are Fannie Mae's HomeReady® and Freddie Mac's Home Possible® programs. These loans allow borrowers to use alternative credit sources, such as bill payment history, making them a feasible choice for those with little or no traditional credit history.

For both programs, the minimum down payment is 3%, but if your down payment is less than 20%, you'll need to pay for private mortgage insurance (PMI). The minimum credit score for Fannie Mae HomeReady® loans is 620, while Freddie Mac Home Possible® loans require a credit score of 660. If you don't have a traditional credit score, both programs allow you to use alternative data to prove your creditworthiness.

How Can You Secure Bad Credit Home Loans?

The road to securing a home loan with bad credit is not without obstacles. However, there are steps you can take to improve your chances:

Review and Improve Your Credit Reports

Before embarking on your home loan journey, it's vital to know your credit reports inside and out. Your credit report is a detailed record of your credit history and a primary tool lenders use to gauge your creditworthiness.

The first step is to obtain a copy of your credit reports from the three major credit bureaus: Equifax, Experian, and TransUnion. Once you have your reports, review them thoroughly for errors, such as incorrect late payment records or discrepancies in the amount you owe. If you find errors, dispute them immediately with the credit bureau that provided the report. Getting these inaccuracies corrected can give your credit score a significant boost.

Lower Your DTI

Debt-to-Income (DTI) ratio is another critical factor in the mortgage approval process. It's a measure of your total monthly debt payments compared to your gross monthly income. The lower your DTI, the better your chances of getting home loans for bad credit.

Improving your DTI might involve paying down existing debts, such as credit cards or student loans, or finding ways to increase your income. The goal is to demonstrate to lenders that you can comfortably handle your monthly mortgage payments alongside your other financial obligations.

Increase Your Down Payment

In the world of mortgages, money talks. The larger your down payment, the less risk you pose to your lender. This is particularly true if you have credit issues. By providing a more substantial down payment, you are purchasing equity in your home upfront, reducing the lender's financial exposure if you default on the loan.

Increasing your down payment may require sacrifices, including cutting back on expenses or setting aside lump sums, such as tax refunds or bonuses. You could also consider assistance from family members willing to provide monetary gifts.

Maintain Timely Payments

On-time payment is the largest contributor to your FICO score, accounting for 35% of the total. By keeping a spotless payment history, you can show lenders you're reliable and capable of managing your finances.

If you've had a history of late payments, it might be wise to establish a consistent pattern of on-time payments before applying for a mortgage. Setting up automatic payments or reminders can be an effective way to ensure your bills are paid on time every month.

Shop Around and Consider a Cosigner

When it comes to home loans, one size doesn't fit all. Different lenders have various criteria and loan products, so it's a good idea to shop around for a loan that best fits your circumstances. Also, using a cosigner or co-borrower with a stronger credit profile could help you secure more favorable loan terms.

Seek a Lower Loan Amount

If you're struggling to get approved for a home loan with your current credit score, you could try a less expensive property, hence a smaller loan amount. This could mean a manufactured home or a house in a less expensive neighborhood. Remember, homeownership doesn't always start with your dream home. It's often a journey of gradual upgrades as your financial situation improves over time.

Arming yourself with these strategies can increase your chances of securing a home loan despite having bad credit. It's about proving to lenders that you're now a reliable borrower.

Should You Get a Home Loan for Bad Credit or Wait?

While home loans for bad credit exist, it's essential to note that they usually come with higher interest rates. Before diving in, weigh the long-term costs and benefits. Sometimes, it might be more beneficial to work on improving your credit score before applying for a mortgage. Making an informed decision is key to a financially secure future. Check out our Bad Credit Home Loans FAQ to learn more.