How to Get a Mortgage With Bad Credit

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The U.S. continues to navigate a global pandemic and now an official recession, and yet home prices continue to rise. 

There are signs it may even be a sellers’ market. This has been driven, in part, by exceptional mortgage rates that have been historically low in recent months.

But just because the advertised mortgage interest rates are so low, that doesn’t necessarily mean those rates will be available to you. We are seeing a wide range of quoted interest rates because the economic uncertainty has made it difficult for lenders to quantify risk, said Matthew Speakman, an economist with Zillow

With lenders becoming more risk averse, only those with the very best credit scores will be able to qualify for the best rates.

According to a 2019 Experian report, the average American’s FICO credit score rose to an all-time high of 703 last year. But that was before the coronavirus pandemic—and even then 41% of U.S. consumers had a FICO score of less than 700. 

So what does this surprisingly active real estate market look like for people with lower credit scores? 

What is Considered a Low 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. As unemployment remains high, lenders have been increasing the credit score requirements for many of their loans. So while it’s not impossible to get a mortgage with “fair” or “poor” credit, there are fewer options for borrowers with credit scores below 700 than there have been in the past.

Getting a Mortgage With Bad Credit Costs More

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 the interest rate of your mortgage can cost you tens of thousands of dollars over the life of the loan. The median home price in the U.S. is about $300,000. With a 20% down payment and a mortgage rate of 3.25% on a 30-year fixed-rate loan, you’d pay $136,141 in interest over the loan term. If you keep everything else the same, and bump the interest rate up to just 3.5%, you’ll pay an extra $12,028 over the life of the loan.

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.

According to MyFICO.com the average national mortgage interest rates are 1.37% higher for a credit score between 620-639 compared to the rate for a credit score between 700-759. That means a credit score difference of as little as 61 points could end up costing you almost $67,000 more if you bought an average home with a 30-year fixed-rate mortgage and put 20% down! Even if you refinanced to a better rate down the road, you could still be on the hook for an extra five figures in interest.

Mortgages You Can Get With Bad Credit

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 Speakman, the Zillow economist. Different lenders may qualify you for 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. So 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, there are organizations 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 women’s guide to homebuying, 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.

Regardless of when you hope to buy a home, you can take steps today to get closer to homeownership tomorrow. You can work on improving your credit score by consistently paying all your bills on time and paying down debt. These are the biggest factors that impact your credit score, so make them a priority. Also, avoid opening new lines of credit and keep existing credit lines open to increase the average age of your accounts.

Having a healthy credit score also 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.