How to Qualify for a Mortgage with Bad Credit

Two Parts:Organizing Your FinancesApplying for a Mortgage

Your credit history is one of the most important details lenders consider when approving you for a mortgage. Bad credit or a low credit score will compromise your ability to get a mortgage, as lenders will consider you at risk of defaulting on your loan. Obtaining a mortgage has become even more difficult due to the struggling economy and the record number of foreclosures in the housing market. However, it may still possible to qualify for a mortgage and buy a home, even if your credit history is far from perfect.[1]

Part 1
Organizing Your Finances

  1. Image titled Contact the IRS Step 17
    Get your credit score. To qualify for a mortgage, you will need your credit score. Your credit score is a three digit number derived from your credit history. It is used by lenders when you apply for a credit card and is a key factor in receiving a mortgage from a lender.[2]
    • You can get your credit score for free by contacting your credit card company. Your bank can also provide your credit score, for a $20 fee or for free during promotional times of the year. Avoid using online credit score services, as they may be scams trying to steal your personal banking information.[3]
  2. Image titled Reduce Your Student Loan Payments Step 6
    Understand what qualifies as a bad credit score. In general, lenders will be more willing to approve a mortgage if a person has a credit score of at least 620. The best credit score is around 850, but it can be difficult to achieve such a high number, especially if you are in a younger age bracket and are trying to purchase your first home.[4]
    • If your credit score is 600 or lower, you will likely have a more difficult time qualifying for a mortgage. But a low credit score does not mean you cannot qualify for certain loans, such as a Federal Housing Administration (FHA) loan, which usually approves individuals with credit scores of 600-500.[5] You may also qualify for a VA loan if you're a veteran.
    • Keep in mind your credit score is only one factor to qualifying for a mortgage. Your current income, your ability to pay your bills on time, your credit history, and your current debt will also be major factors to getting a lender to approve your mortgage application.
  3. Image titled Retire Rich Step 17
    Maintain a steady income. When lenders look at your mortgage application, they will take into account your ability to pay your current expenses (rent, utilities, credit card payments) on time every month. They will also check that you have been employed with a steady income for at least two years and are making enough money to pay all your bills every month.[6]
    • If you are self employed, you should try to maintain a steady yearly salary. Being self employed and having a low credit score can lead to some frustration when applying for a mortgage. But maintaining a strong income will give you a leg up, and make it easier for a mortgage broker to find lenders willing to give you a mortgage.[7]
  4. Image titled Prepare a Budget Step 6
    Reduce or eliminate your debt. Debt from student loans or overdue credit card payments will affect your credit score, as about 35 percent of your credit score comes from your payment history. Focus on reducing your existing debt by always paying the minimum amount of your credit card payment and your student loan payment on time. If possible, put down more than the minimum amount each month to further reduce or eliminate your debt.
    • Look at your credit report for any past due accounts or late payments. If you have accounts, like a student loan payment, that is 90 days or more overdue, pay those off first. Accounts that are 60 to 30 days late will have a less negative impact that accounts that are 90 days or more late.[8]
    • Lenders will see that you have been making an effort to pay off overdue accounts and reduce your existing debt. This will bring your credit score up and help improve your chances of qualifying for a mortgage.
  5. Image titled Get a Credit Card With No Credit Step 10
    Adjust your debt to income ratio. To qualify for a mortgage with poor credit, you may want to adjust how much money you owe (debt) so it is significantly lower than how much credit you have available (income). Improving your debt to income ratio is one of the fastest ways to improve your credit score and make you more attractive to lenders. You can improve your debt to income ratio by:[9]
    • Pay down your revolving debt, like credit cards and lines of credit. Though paying down installment loans, for example student loan payments, can also help your credit score, revolving debt should be your first priority to improve your credit, since revolving debt requires high interest payments.
    • Consolidate your credit card debt into a personal installment loan. A personal installment loan can be taken out through your bank and will allow you to address all your debt in one place. This type of loan generally has a lower interest rate than revolving credit card balances.
    • Adjust how you pay your credit card payments. You can do this by asking for a credit increase from your credit card company, as this will improve your debt-to-credit ratio. Credit increases are valid for helping improve debt to credit ratios, but not if you use the extra credit. You can also move some of your existing credit card balances to other credit cards. However, both options can be risky as they can lead to overspending and more debt if you are not disciplined or smart about your credit card payments. The best way to address credit card payments is to pay off the minimum balance every month and try to reduce your credit card debt as soon as possible.
  6. Image titled Do a Monthly Budget Step 3
    Be prepared to pay more interest on your mortgage. When you have bad credit or a low credit score, lenders may offer you a sub-prime mortgage. Lenders charge higher interest rates on sub-prime mortgages to compensate for the higher loan default risk they are taking on the mortgage. This works the other way too: the better your credit score is, the lower your interest rate on your mortgage will be.[10]
    • According to a study, the difference in interest rates for someone with a 760 credit score and someone with a 620 credit score could be 1.6%. If you apply this number to a 30 year mortgage of $200,000, that’s a $68,000 difference over the lifetime of the mortgage.[11]

Part 2
Applying for a Mortgage

  1. Image titled Do a Monthly Budget Step 11
    Look into a Federal Housing Administration (FHA) loan. The Federal Housing Administration (FHA) is a division of the U.S. Department of Housing and Urban Development.[12] If you don’t qualify for a conventional mortgage, you may want to consider getting a mortgage through the FHA. FHA loans can have down payments as low as 3.5% and are often available for individuals with credit scores between 500-620.[13]
    • Keep in mind the lending banks make the final decision to grant you a loan, not the FHA. The FHA partners with banks to insure part of your loan. In the event you default on the loan, the FHA is required to pay the guaranteed portion. This is meant to entice banks to offer loans to high risk borrowers with low credit scores.[14]
    • In order to qualify for a FHA loan you will need to maintain a credit score of 500-620 and maintain a handle on your debt. You should also establish a steady income over a period of two to three years.
    • You can also look into getting a VA loan if you are a veteran. Check | here to see if you qualify.
  2. Image titled Prepare for a Job Interview Step 2
    Provide an explanation for your bad credit to lenders. Another option is to talk to your bank about your low credit score and try to explain your credit history. Bring in proof of on time payments of your rent and your utilities for at least 12 months. If you have a steady income, you should also provide proof of this to your bank. Go over your credit history with the lender, especially if there are small late charges that may have affected your credit score. Lenders can be more amenable to borrowers who can show they will be able to pay their mortgage on time in the future, despite a rough credit history.[15]
    • Your bank may also view issues in your credit history on a descending scale. A late medical bill or student loan payments are common issues that can cause your credit score to drop and can lead to bumps in the road to getting a mortgage. But your bank will likely view defaulting on a car loan as a much worse credit issue than student loan payments or one late medical bill.
  3. Image titled Succeed in Network Marketing Step 4
    Ask your realtor about a lease to own agreement. If your credit score is too low to qualify for a loan from a traditional lender, or you cannot afford a 3.5% down payment on an FHA loan, you may consider a lease to own or rent to own agreement. A lease to own agreement is made between a homeowner or landlord and a tenant or renter. As part of the agreement, a portion of your monthly lease payment goes towards purchasing the home and the rest is considered a rent payment. Lease to own agreements can be difficult to find and you may need to consult with a realtor to find a homeowner who is willing to enter into an agreement. Most lease to own agreements are done with homeowners can’t sell their home at the asking price or when the housing market is a buyer’s market.[16]
    • Most lease to own contracts last for two to five years. These contracts can be good for people with low credit as it provides time to save for a down payment, repair the credit score, and try out the home before buying it. Some contracts give you the option to walk away from the home while still under contract, but this may mean the homeowner keeps all the money you have paid them as a down payment.[17]
    • You may also want to look into a seller-financed loan. In this case the seller extends credit to the buyer, and a mortgage agreement is filed. A seller is more likely to offer this arrangement if the seller's mortgage has already been paid off.[18]
  4. Image titled Handle an Employee's Attendance Problems Step 6
    Find a co-signer for the mortgage. If you have family members or a partner with good credit, consider asking them to co-sign a mortgage for you. However, be wary of co-signing for a home you cannot afford. If the monthly mortgage payments are too high for your budget, you may end up entering into a co-sign agreement for a home you will lose in a year.
    • Co-signing can also be risky as you are involving family with money, and you may end up putting those relationships in jeopardy if you can’t afford your mortgage payments.
  5. Image titled Prepare for a Job Interview Step 4
    Consider waiting until your credit improves to apply for a mortgage. If your current financial state needs improvement, or if your credit score is too low to qualify for an FHA loan, it may be a good idea to hold off on applying for a mortgage.
    • Take some time to improve your credit score and re build your credit history. Then, apply again for a mortgage in two to three years, with a better credit score, a steady income, and a stronger handle on your debts.

Things You'll Need

  • Your credit score
  • Proof of steady income

Sources and Citations

Show more... (15)

Article Info

Featured Article

Categories: Featured Articles | Mortgages and Loans