The hard, cold truth is that there are numbers that rule our lives. You had to have a high GPA to get into your dream college as well as a good SAT or ACT score. You also need a high credit score to get a loan for that dream house. Mortgage lenders like almost all lenders tend to look at your credit score in ranges. Here’s how to know if you have bad credit.
- Excellent Credit: 781 – 850
- Good Credit: 661-780
- Fair Credit: 601-660
- Poor Credit: 501-600
- Bad Credit: below 500
According to the data from CNBC.com, 20% of homebuyers have a FICO credit score that is lower than 700. This is good credit but is
It’s not just the number
However, if you have bad credit today it may not just be as a result of your number. It could be a matter of timing – like a foreclosure, short sale or rolling late charges – and not just your three-digit credit score. But regardless of why you have bad credit, the fact is that you do but would still like to get a mortgage loan. So what can you do?
Save up a larger down payment
If you check your credit score and find that it’s below 580 then it will be necessary for you to have a bigger down payment. This is not an option. However, if your score is in a slightly higher range you might still put more money upfront to compensate for that low score. This will probably mean a down payment of 20% of the home’s value or even higher. According to the data from RealtyTrac.com, the average down payment in 2015 was 14.8%. When you make a larger down payment this represents a signal to lenders that you have the ability to handle the loan despite your poor credit history. When you do this it also increases your equity in the house upfront, which will immediately lower your loan-to-value ratio. The idea behind this is that the more you invest in that house, the less likely you will be to default, which means less risk to your lender – even if your credit score is less than stellar.
Get an FHA loan
Given the fact that you have a poor credit score your best bet would be to apply for an FHA loan, which would be backed by the Federal Housing Administration. This is because the guidelines for these loans tend to be much more lenient than loans owned by Freddie Mac or Fannie Mae. In fact, according to the Department of Housing and Urban Development – which oversees FHA loans – you can get approved for one of these loans with a credit score as low as 580 so long as you are able to come up with a down payment of at least 3.5%. In comparison, to get a conventional loan would require a score closer to 620 or 640.
Understanding an FHA loan
While an FHA loan could be your best option it’s important to understand its advantages and disadvantages. Of course, the biggest advantage is that it could make it possible for you to buy a home and with a lower down payment than would be required for a conventional loan. However, there are some downsides to an FHA loan. For example, while your initial mortgage interest rate might look very appealing there are underlying insurance fees that will add major expenses to the loan. This insurance fee is currently 1.75% upfront. Supposing you would need a $150,000 loan to buy a house then your insurance fee would be $2625. Plus, there will be a continuing monthly fee of 0.85% if your mortgage will be for 15 years or more with a loan-to-value ratio of more than 95.01%. If your loan-to-value ratio drops to less than 95% then your monthly fee would be 0.80%. And that mortgage insurance will be with you for the life of the loan.
Most lenders today use an automated system to determine whether or not you would be a good candidate for a mortgage loan. But if you’re deemed ineligible by the system you might still qualify for a loan. Lenders can go the route of manual underwriting and set your low score aside if you can demonstrate that you are financially stable in other ways. As an example of this, you might be able to show that you’ve been making your rent payments on time for the past year or more or that you have enough cash reserves to carry you for at least six months. A high income and low debt payments could also show that you are less risky as a loan candidate. Plus, you should be ready to explain why you have a bad credit score to begin with. If you have a large amount of consumer debt that’s gone to default this will signal irresponsible behavior and use of credit. However, if the majority of your debt is student loan debt this could tell a completely different story.
Try to get a private mortgage
When you think of getting a mortgage the first thing you undoubtedly think of is to go to a large financial institution. Fortunately, there are other ways to get a loan when you have bad credit such as a private mortgage loan. These loans can come from anybody that has the cash on hand to pay for your home in full. For example, this could be a friend, a private lender or a family member. You would pay for the home with a loan based on the terms accepted by both parties. There are some potentially big downsides to this type of loan like high fees and a high probability of relationship turmoil. However, if you can get a private mortgage this essentially eliminates the fact that you have a poor credit score.
The bottom line
Fortunately, if you have bad credit there is never a never you’ll you get a loan. You could still get a mortgage despite that little three-digit number. Keep working, explore all the alternatives you can find and don’t give up hope. You will ultimately be able to get a mortgage and realize that dream of owning your own home.