Government-backed loans or Special Homebuyer Programs may be the solution you need
If you have a low credit score, you may feel that your dream of homeownership is hopeless. But that is the wrong outlook. There are financial strategies and mortgage loans out there that could help you realize your dreams – even if you have bad credit. Here is what you need to know to get a mortgage with a low credit score.
Is it possible to buy a home with poor credit?
Yes—it is possible to buy a home with poor credit. But because mortgage interest rates rise as your credit score drops, receiving a home loan with poor credit will likely cost you more money. In fact, throughout the life of your loan, even a seemingly negligible gap in your mortgage interest rate will cost you upwards of tens of thousands of dollars. For instance: for anyone with a credit score between 700 and 759, the average national mortgage interest rate is 2.85%. For anyone with a credit score of 620 to 639, the average national mortgage interest rate sits at 4.22%. That makes it a 1.37% difference between the two rates.
In April of 2021, the median house price in the United States was roughly $370,000, meaning that with a 20% down payment and a 30-year fixed-rate loan, you would pay roughly $145,000 in interest over the life of the loan (with the higher credit score). If you had the lower credit score, on the other hand, you would pay about $227,000 in interest over the life of the loan. That’s a difference of just over $80,000.
The bottom line is that while it is possible to buy a home with poor credit, it would be in your financial interest to improve your credit score prior to getting a mortgage. Doing so could save you tens of thousands of dollars in interest during the life of the loan.
What are considered bad credit scores?
Credit scores, which are calculated by a variety of credit scoring models, typically fall into the following classifications:
Exceptional: 800 to 850
Very good: 740 to 799
Good: 670 to 739
Fair: 580 to 669; and
Poor: 300 to 579.
To qualify for a mortgage, the minimum credit score required differs by the type of loan as well as the lender. It should be noted that it is not impossible to receive a mortgage with a poor or fair credit classification. In that case, however, you will likely find fewer options—as well as higher interest rates. That limitation exists for anyone with a credit score under 700.
How do you qualify for a home loan with poor credit?
Your mortgage options may be limited if you have a lower credit score, which usually weaken your mortgage application. It is still possible, however, to qualify for a home loan with poor credit. You can still strengthen other aspects of your loan application to better your chances of receiving approval with bad credit. These include the following:
Your DTI. Your DTI, or debt-to-income ratio, will be reviewed by lenders to ensure that you can afford your mortgage repayments. Your financial situation will be more attractive to lenders if you are able to pay off some of your debts, or earn a raise, prior to applying.
Your down payment. Since you are putting more of your own money on the line, placing a larger down payment will make your loan application stronger.
Your cash flow. Your application will appear less risky to underwriters if you can show your lender consistent income for two years or more, either through tax returns or W-2 forms.
Choice in homes. Your odds of receiving approval will be better if you find a property that you can easily afford rather than a home that stretches your funds each month. But don’t worry—you can upgrade after you have built some equity and strengthened your credit profile.
Types of mortgage loans you can get (even with poor credit)
There are types of mortgage loans you can get, even with poor credit. In fact, lenders typically offer loans designed specifically for people with low to moderate income levels. Here are a couple types of mortgage options available to you if you have bad credit:
Government-backed loans. Government-backed loans are commonly available for anyone with poor credit. These types of loans are typically underwritten and given by approved lenders, yet are still government guaranteed. Since these mortgages are not as risky for lenders, they have lower credit score requirements.
Special Homebuyer Programs. Some of the more popular homebuyer programs include the Neighborhood Assistance Corporation of America (NACA) and Habitat for Humanity. There are also smaller local, regional, and state-level programs that will help qualified first-time homebuyers or anyone who has fallen within specific income limits. While these programs usually offer down payment or closing cost assistance, they usually provide services, or mortgages, to borrowers with poor credit.