Qualifying for a mortgage with bad credit

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Between rising mortgage rates and a hot seller’s market, right now might be the best and worst time to buy a house. 

If you’re hoping to secure a below-market mortgage interest rate across the board, be aware: just because the advertised rates are low doesn’t necessarily mean those rates will be available to you. 

During the economic uncertainty of the COVID-19 pandemic, many lenders tightened their requirements to mitigate risk. Even though economic recovery now is on the horizon, exactly when and to what degree lenders will start to relax their lending criteria again remains to be seen.

So what does the current real estate market look like for people with lower credit scores? 

What Do Mortgage Lenders Consider a Bad Credit Score?

There are several different commonly used credit scoring models, such as VantageScore and FICO. FICO score ranges from 300-850. According to the credit monitoring bureau Experian, credit classification falls into these ranges:

• Exceptional: 800-850
• Very good: 740-799
• Good:670-739
• Fair: 580-669
• Poor: 300-579

The minimum credit score you need to qualify for a mortgage varies by lender and the type of loan. While it’s not impossible to get a mortgage with “fair” or “poor” credit, there may be fewer options, with higher rates, for borrowers with credit scores below 700.

Can You Buy A House With Bad Credit?

Mortgage interest rates go up as a borrower’s credit score decreases. So getting a home loan with bad credit is going to cost you more. 

Even a small difference in your mortgage interest rate can cost you tens of thousands of dollars over the life of the loan. According to MyFICO.com, the average national mortgage interest rate for those with a credit score between 700 and 759 is 2.85%. The average rate for those with a credit score between 620 and 639 is 4.22%. The difference in rate between the two is 1.37%. The median home price in the U.S. in April 2021 was about $370,000.  With a 20% down payment and a 30-year fixed-rate loan, the person with the higher credit score would pay $144,713 in interest over the life of the loan, while the person with the lower credit score would pay $226,684—a difference of $81,971. 

Pro Tip

Improving your credit before you get a mortgage can save you tens of thousands of dollars in interest over the life of the loan.

When underwriting a mortgage, lenders look at more than just your credit score. So, having poor credit isn’t always the end of the road. Your income, overall debt, and how much cash you have on hand are also considered when assessing your ability to repay a mortgage. This makes shopping around crucial because every lender will assess a borrower differently, says Matthew Speakman, an economist with Zillow. Different lenders may offer you better rates.

Lenders also offer loans specifically designed for those with low to moderate income levels or for first-time homebuyers. These loans typically have lower credit score requirements and are worth looking into if you qualify. So be sure to ask your mortgage broker or lender what options are available for you. 

Here are a few types of mortgage options if you have bad credit.

Government-Backed Loans

A common type of loan available for those with poor credit is a government-backed loan. While these loans are underwritten and issued by approved lenders, they are still guaranteed by the government. These mortgages are less risky for lenders, and therefore can have lower credit score requirements.

The most common government-secured mortgages are FHA, VA, and USDA loans. According to the loan guidelines set by the FHA, you can qualify with credit scores as low as 580 with 3.5% down or 500 with 10% down. USDA and VA loans don’t have a mandated minimum credit score, however, most lenders require a score of 580-640.

But these guidelines are the floor, and recently lenders have increased their standards for many government-secured mortgages. You used to be able to get an FHA loan with a 580-600 credit score, but now restrictions are tighter due to the pandemic, said Alex Borge, a housing counselor with the nonprofit HUD-approved counseling agency Debthelper.com. Some lenders have increased their requirement to 700 on FHA loans, he said. 

Special Homebuyer Programs

As we’ve covered, the increased cost of borrowing for a home purchase when you have bad credit can make homeownership an unreasonable financial burden for many. Thankfully, organizations are working to solve this problem. While these programs aren’t specifically focused on serving people with bad credit, organizations like Habitat for Humanity and the Neighborhood Assistance Corporation of America (NACA) can help if you find yourself in that situation.

Both organizations have specific steps and qualifications an interested homeowner must meet. Habitat for Humanity doesn’t have a nationwide minimum credit score requirement; instead, it varies by affiliate, but it is possible to qualify, in some areas, with a score under 600. To purchase a home through the program, you’ll need to fall into an income range (designated by where you’re purchasing), take financial education classes, and invest “sweat equity” into your future home by volunteering with the program. The reward for these efforts is a zero-interest loan with minimal closing costs and a down payment for as little as $500.

Working with the nonprofit Neighborhood Assistance Corporation of America (NACA) can be another excellent option if your credit score is keeping you from qualifying for other loans. NACA works with lenders to provide mortgages with no down payment, no closing costs, below-market interest rates, and no credit score requirements. To qualify, you’ll need to go through a lengthy process, attending classes and working with a financial counselor. NACA only works with people purchasing in a low-to-moderate income area or those who have low-to-moderate income. The area’s median family income is used to determine the income requirements.

There are also many smaller local, regional, and state-level programs offering assistance to qualified first-time homebuyers or those who fall within specific income limits. These programs often offer closing cost or down payment assistance, but also may provide services, or mortgages, to borrowers with weaker credit scores.

Should You Get a Home Loan With Bad Credit?

If you’re having trouble qualifying for a mortgage that works for your situation, then it might be a good idea to take a step back. Justine Chan, real estate agent and founder of Live With Plum, a woman’s guide to home buying, suggests borrowers with bad credit ask themselves if it is absolutely essential to buy right now or if there is time to fix their credit first.

Having a healthy credit score isn’t the only thing to work on as you move toward homeownership. The biggest mistake homebuyers make is not understanding the implicit cost of owning a home and how much closing costs are, Chan believes. So increasing your savings is also important. 

Having more money in the bank makes it easier to cover closing costs, makes you a more appealing borrower, and puts you in a better position to handle unexpected home repairs. “The last thing you want to do after making a $200,000 purchase is take out another loan,”  Borge said. He recommends having at least 3% to 5% of the purchase price set aside, in addition to any closing cost or down payment assistance you may qualify for, to cover moving and home expenses. 

How to Improve a Bad Credit Score Quickly

Improving a bad credit score takes time, so it’s best to start early. Here are some things you can do right now to fix your credit:

• Pay off your credit cards on time and in full. Of the five factors that affect your credit score, payment history has the biggest impact. Payments more than 30 days late can significantly hurt your credit score. Late payments may stay on your credit report for seven years. If you’re able to, try to pay off your bill in full to avoid carrying a balance month to month. 
• Lower your credit utilization ratio. Your credit utilization ratio, or how much you borrow divided by your total credit line, also plays a big part in your credit score calculation. Try to keep it under 30% if possible. There are several ways to do this: reduce your spending on your credit cards, apply for a credit line increase, or pay off your balance more frequently than once a month. 
• Don’t open unnecessary credit accounts. Every time you apply for a loan or credit card, the lender will perform a hard credit inquiry. Each hard credit inquiry will lower your credit score by a few points and typically stay on your credit report between one and two years. If you’re planning to apply for a mortgage in the near future, try to limit the amount of new debt you take on. 
• Regularly monitor your credit report and dispute any errors. It’s important to keep a close eye on your credit report to catch and fix any errors or fraud early. The three credit bureaus that issue credit reports are Equifax, Transunion, and Experian. You can get a free copy of your credit report from all three bureaus every year at annualcreditreport.com. If you spot any mistakes, you should immediately contact the credit bureau that issued the report to dispute the error.