Getting approved for a mortgage can be pretty challenging these days. Lenders are rather stringent with their lending requirements and aren’t in the business of loaning out money to just anyone. Nowadays, you’ve got to meet strict criteria in order to get approved for a conventional mortgage, and that includes having good credit.
But what if your credit score isn’t up to par? Are your dreams of buying a home and achieving the American Dream quashed?
Not at all. if you follow a few steps, there’s little reason why you shouldn’t be able to get approved for a home loan, despite your bad credit.
Check Your Credit Score
The first thing you should do before you start applying for a mortgage is pull your credit report. This will tell you exactly what your credit score is right now, as well as the reasons why your score may be where it’s at. If your score is anywhere below 680, you may have trouble getting approved for a conventional mortgage.
Another reason why it’s important to pull your credit report is to see if there are any mistakes that are unnecessarily pulling your score down. Even just one small mistake can shave off a few points from your credit score. It’s not uncommon for creditors to make a mistake when reporting behaviors of consumers. In fact, it’s estimated that about one-quarter of Americans discover errors on their credit reports.
If you notice any errors, have them investigated. Fixing them can add a few points to your overall score.
Make a Larger Down Payment
There are a few important things that lenders look at when they determine the eligibility of an applicant for a mortgage, and one of them is the loan-to-value (LTV) ratio. Essentially, an LTV is a measure of the loan amount relative to the value of the property being purchased. The closer the loan amount is to the value of the home, the less favorably lenders look upon borrowers.
That’s because there’s an inherent risk for lenders when they loan out close to – or at – the market value of a property. The way to widen the gap between the loan amount and property value is by making a larger down payment The more money you put towards a down payment, the less you’ll have to borrow. Not only will lenders be more likely to approve your home loan application, you’ll also have less of a mortgage to repay.
For applicants with bad credit, a larger down payment is even more important. If your score is considered sub-par, it’s helpful to make up for it in other areas, such as your down payment amount.
Pay Down Some of Your Other Debt
Before you apply for a mortgage, you may want to consider paying down some of your other debt first. A higher debt load will negatively affect your debt-to-income (DTI) ratio, another important factor that lenders seriously consider when determining whether or not to approve a mortgage.
Your DTI is simply a ratio of your monthly debt payments to your monthly net income. Even if you make a handsome salary, it can be offset by all the bills you have to pay. For instance, if your current monthly debt load is $2,000 and you bring in $5,000 a month, your DTI would be 40% ($2,000 ÷ $5,000). Ideally, lenders like to see DTI ratios no higher than 43%. Anything more would be considered too risky.
By paying down some of your debt, you can reduce your DTI. This will make it more likely that lenders will approve your home loan application.
Work With a Bad Credit Lender
While the bank might not necessarily approve your application for a mortgage with a bad credit score, there are other lenders out there who probably would. Many lenders work specifically with borrowers who have bad credit. Working with mortgage brokers can prove to be crucial in this situation, as they will be able to put you in touch with lenders who deal exclusively with bad credit borrowers.
Consider an FHA-Back Mortgage
Perhaps one of the more popular loan options for those with bad credit is the FHA-backed mortgage product. With this type of mortgage, the minimum credit score required is 500. Mortgages backed by the Federal Housing Administration (FHA) generally have lending requirements that are much more flexible than conventional bank loans.
If your credit score is between 500 and 579, you will need a down payment of 10% of the purchase price with an FHA home loan. If your score is 580 and above, you can put down as little as 3.5%.
In order to qualify for an FHA mortgage, the house you are planning to buy must meet certain property requirements. Essentially, the property must meet specific safety and habitation standards as established by the FHA.
In addition, you will be responsible for paying mortgage insurance, both upfront and on a yearly basis. The annual premiums for this type of insurance range from 0.80% to 1.05%, depending on the loan amount and loan-to-value ratio. The upfront premium is typically 1.75%.
FHA mortgages aren’t the only bad credit mortgages that borrowers can tap into. Others include:
- Fannie Mae HomeReady program – Minimum credit score is 620
- USDA loans – Minimum credit score is between 620 and 640
- VA loans – Minimum credit score is between 620 and 640
The Bottom Line
Having bad credit certainly puts a wrench in your mortgage approval process, but that doesn’t mean you can’t get approved by taking a different route. There are options available for borrowers with bad credit scores. Just work with a seasoned mortgage broker who can assess your situation and suggest the best path for you to take to finally realize your dreams of homeownership.