One of the best things you can do when preparing your mortgage application is to understand the role credit plays in approval. Once you understand how a lender views you and your credit, you can work to craft your financial story to work in your favor.
We’re taking an in-depth look at the role of credit in the mortgage process, loan options for people with bad credit and how you can make your credit score better before you apply for a loan.
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How To Get A Mortgage With Bad Credit
No matter which lender you choose, it’s going to be difficult to find one that will accept a credit score lower than 580. If you want to proceed with getting a mortgage with bad credit, your next step is to learn what types of loan you could qualify for.
If your credit score is lower than 580, you’re going to have to work to increase it before you apply for a loan.
Your credit score is a number based on your available credit, the amount you owe, length of your credit history, payment history and any new credit you’ve taken on. Though it’s important, it’s not the only factor a lender considers.
Lenders consider more than just your credit score. They use your credit to determine other values, including:
- Debt-to-income ratio (DTI): Your DTI is your monthly debt payments divided by your monthly income. This percentage tells a lender how much of your income goes straight toward paying debts. You want your DTI to be as low as possible.
- Loan-to-value ratio (LTV): The LTV of a property is the amount borrowed from the lender divided by the cost of the property. The lower your LTV, the less risky you are for the lender.
If your credit score is on the lower end of what lenders are willing to accept, government-backed loans could be an option for you. These loans are backed by government and allow lenders to take on the increased risk you pose with your low credit score.
Compare your financial situation to the guidelines for these government-backed loans to see if they might be a good fit for you:
1. VA Loan
If you are a house-hunting veteran, active military member or qualified spouse with less-than-perfect credit, VA loans could help you get a loan. VA loans don’t require a down payment, allow for a higher DTI and the credit score requirement tends to be around 620.
The interest rate you could qualify for with a VA loan could also match that of conventional loans, as your financial history won’t lock you into an impossibly high rate. You’ll want to consider loan limits, though. If you go with a VA loan, the amount you can borrow is capped, which would limit the amount of home you can get.
FHA loans are backed by the Federal Housing Administration and also have less-strict criteria compared to conventional loans. They do have a down payment requirement. The DTI and credit score expectations are also lower than conventional loans. If you pursue an FHA loan, your down payment expectation is around 3.5%.
Backed by the U.S. Department of Agriculture, USDA loans are mortgages available for rural and suburban homebuyers. These loans don’t require a down payment, but if you put very little money down, they do require mortgage insurance. Despite this, they are still one of the most affordable mortgages available.
Applying With A Low Credit Score
If you want to apply for a home, you can better your chances by working to increase your credit score.
1. Put Down A Larger Down Payment
The larger the loan amount, the riskier you are to a lender. As we stated earlier, the higher the LTV ratio, the harder it is for you to get a loan. Let’s look at an example:
If you want to get a loan for $175,000 and the property costs $200,000, your LTV is 0.875, or 87.5%.
If you want that same $200,000 house but only asked for a $140,000 loan, your LTV would be 0.70, or 70%.
If you apply for a USDA or VA loan, your LTV is going to be 100% because you are not required to produce a down payment.
2. Manage Your DTI Ratio
As mentioned earlier, DTI is one of the important factors considered in your loan application. It measures how much of your monthly income goes directly toward paying off debts. A lender is less likely to give you a loan if you have a high DTI because it will be harder for you to pay off debt at your income level.
One way to lower your DTI is to reduce the debt you’re currently paying off so you’ll be able to make payments on your mortgage. One way to do this is to pay off credit cards and personal loans. You can also help your DTI by minimizing how much you charge on your credit cards.
This relates to a factor lenders consider called credit utilization ratio. It represents how much of your available credit you use. If you have a credit card limit of $10,000 and you have charges that add up to $5,000 on your card, your credit utilization ratio is 50%. Lenders look favorably on lower credit utilization ratios.
How To Improve Your Credit
If you’ve compared your financial profile to lenders’ expectations and want to improve your credit before applying for a loan, you’re headed in the right direction. Getting a mortgage becomes easier when you understand how a lender views you.
Here are some small steps you can take to help increase your score:
Step 1: Pay Balances On Time
Payment history is one factor in determining your credit score. Make a conscious effort to pay balances in full and on time. Download the mobile app for your bank and set up auto pay to ensure timely payments are being made.
Step 2: Review Your Credit Report
You are allowed to review your credit report for free once a year. Take this opportunity to look for errors and make sure they’re changed. Any errors could hurt your score and make it harder for you to get the mortgage you want.
Rocket HQ, a sister company to Rocket Mortgage® by Quicken Loans®, allows you to get your free TransUnion Credit Report and track your VantageScore 3.0 credit score. You can also connect with a financial expert to discuss your score and create a plan to improve it.
Step 3: Don’t Open New Lines Of Credit
In the period that you’re attempting to raise your score and secure a mortgage, try not to open any new lines of credit. Every time you open a new credit card, your credit score can go down. Though this is not always the case, try not to open a new card unless it’s 100% necessary.
Step 4: Underutilize Your Credit
Keep your card balance low and work to pay balances in full and on time.
If you’re trying to get a mortgage with bad credit, start by understanding how you are viewed by lenders. Look at the important application factors – credit score, DTI, and LTV – and compare government-backed options.
Ensure that loan limits won’t prevent you from getting the amount of home you want. If you would rather wait and work on your credit, there are actionable steps you can take to better your score.
Frequently Asked Questions
1) Q: How do I get pre-approved?
First, you need to fill out an application and submit it to the lender of your choice. For the application you need 2 previous years of tax returns including your W-2’s, your pay stub for past month, 2 months worth of bank statements and the lender will run your credit report. Once the application is submitted and processed it takes anywhere from 2-7 days to be approved or denied. Check out our top lenders and lock in your rate today!
2) Q: How much interest will I pay?
Interest that you will pay is based on the interest rate that you received at the time of loan origination, how much you borrowed and the term of the loan. If you borrow $208,800 at 3.62% then over the course of a 30-year loan you will pay $133,793.14 in interest, assuming you make the monthly payment of $951.65. For a purchase mortgage rate get a quote here. If you are looking to refinance you can get started quickly here.
3) Q: How much should I save for a down payment?
Most lenders will recommend that you save at least 20% of the cost of the home for a down payment. It is wise to save at least 20% because the more you put down, the lower your monthly payment will be and ultimately you will save on interest costs as well. In the event that you are unable to save 20% there are several home buyer programs and assistance, especially for first time buyers. Check out the lenders that specialize in making the home buying experience a breeze.