Looking for a mortgage loan with bad credit? Believe it or not, you may be able to seal the deal even with a credit score below 620. You’ll just have to be willing to jump through a few hoops.
First, you’ll need to know where you stand. You can get your credit report for free once a year at AnnualCreditReport.com. You can also pull a free credit report summary every month from Credit.com.
Here’s what to expect when you’re ready to apply.
1. You have limited options
The only program out there for applicants with credit scores below 620 is the Federal Housing Administration. Fannie Mae and Freddie Mac offer conventional loan financing with a hard credit score requirement of 620. Generally, you’ll need a minimum score of 600 to buy a home or get a mortgage.
2. There are stringent income requirements
The lower the credit score, the more risk the lender takes in approving your loan. To minimize your chances of defaulting (and to protect themselves from a legally), lenders now require consumers have a 43% debt-to-income ratio, consistent with the Consumer Financial Protection Bureau’s definition of a “qualified mortgage.”
In other words, your existing monthly loan obligations such as an auto loan or credit card balance, in addition to your proposed mortgage payment, can’t exceed 43% of your total monthly income.
For example, if your mortgage payment is $2,800 per month, consistent with 3.5% down FHA loan on a $425,000 home, and you also have other payments on tax obligations and car payments at $600 per month, you must be earning $7,906 of income to offset the liabilities.
3. You may have to complete homeownership counseling
Some mortgage companies require consumers with bad credit complete online counseling to ensure they fully understand what homeownership entails. (It doesn’t matter if you are refinancing or have previously owned a home.) Typically, this counseling can be completed online. If required, get it done early in the loan process as a sign of good measure.
4. You’ll face higher rates and pricing
Your mortgage, unfortunately, will cost more in fees and interest due to your bad credit. Lenders charge in accordance with the risk they are taking. For example, a borrower with a 620 credit score will pay a rate that’s approximately 0.5 percentage points higher, and approximately $2,000 more in loan fees than a borrower with a credit score of 620 or higher, based on FHA’s risk-based pricing.
Raising your credit score to 620 or higher will help you qualify for better rates. Mortgage lenders may use an industry-specific version of your credit in their underwriting process, so there’s a chance the score they see will differ slightly from the one you are looking at.
The bigger picture
Keep in mind, buying a home and making on-time mortgage payments may cause your score to rise. This improvement in turn could help you qualify for refinancing down the road, netting you a lower interest rate and a more affordable monthly payment.
Talk to your mortgage professional about your credit and the means you currently have to buy a home while considering what options make the most financial sense for you overall.