One of the most challenging loans to get approved for is a mortgage loan.
Many people with bad credit don’t even bother applying for a mortgage because they assume that they’ll instantly be denied.
Can You Get a Mortgage Loan with a Low Credit Score?
A study by the Fair Isaac Corporation, or FICO, which is the most widely used type of credit score among lenders, found that credit scores for new mortgage originations have been dropping since tighter credit policies were enacted after the housing crisis.
New mortgage loans with credit scores less than 700 increased from 21.9 percent of all mortgages in 2009 to 29.7 percent in 2017. These include subprime loans for borrowers with scores in the 400s.
New mortgages with FICO scores less than 750 increased from 41 percent to 53 percent during the same time.
Loan originations for FICO scores of less than 650, which are considered mediocre or bad scores, increased from 9.1 percent in 2009 to 10.9 percent in 2017.
The truth is, there are options when it comes to getting a mortgage with bad credit.
How to Get a Mortgage with Bad Credit
While there are several options for getting a mortgage with bad credit, there will be compromises you’ll likely have to make. What it boils down to is that you will have to pay more than if you didn’t have bad credit.
Each option for getting a mortgage loan with poor credit has its pros and cons. Let’s get into some of the options you have.
Apply for the FHA Program
The first point to keep in mind is that having a bad credit score, usually under 650, is going to prevent you from conventional loan approval. The simple fact is that traditional mortgage lenders generally steer clear of bad credit.
However, the Federal Housing Administration does have a program to help people who have bad credit get approved for a mortgage loan. It’s important to understand that an FHA loan isn’t actually the FHA lending you money to buy a house. Rather, when you’re approved, the FHA will basically guarantee the loan. In other words, if you are unable to make your loan payment, the FHA will pay the lender.
FHA approval greatly increases your chances of getting approved for a mortgage. However, not everybody will be approved. For a full rundown of the credit requirements for an FHA loan, check out their website.
Get an Adjustable Rate Mortgage (ARM)
When you have bad credit the fixed interest rate you’ll get approved for will likely be too high and expensive. In order to keep your interest rate affordable, you may have the option of an adjustable interest rate. Otherwise known as an Adjustable Rate Mortgage or ARM.
An adjustable-rate may be a way to keep your interest payments at an affordable rate. However, adjustable-rate mortgages aren’t without their risks.
The risk, of course, is that since the interest rate is adjustable, it goes up and becomes unaffordable. Before taking out an ARM be sure and do your research. That said, here are a few questions you should be asking your mortgage lender before taking out an ARM loan.
- How much can your interest rates fluctuate with each adjustment?
- How often and soon could your rate possibly go up?
- Are there any limits on how much the rate could increase?
- Are there any caps on how much the rate could increase?
Ask Somebody to Co-Sign on the Loan
When you get somebody to co-sign on a mortgage loan, you can get the mortgage even if you have bad credit. Keep in mind that the co-signer would be fully responsible if you don’t make the payments.
This is a risky option because it could easily ruin close relationships with friends or family. This is especially true when it comes to a mortgage loan because it’s likely a very large amount of money being borrowed. In general, financial advisors recommend against this for that very reason.
FHA loans also allow for co-borrowers, which are similar to co-signers but don’t hold an ownership interest in the property.
Improve Your Credit Before Getting a Mortgage
A high mortgage rate can literally cost you hundreds of dollars a month. Therefore, it’s well worth the little effort it takes to clean up your credit report and improve your credit score prior to getting a mortgage loan.
Out of all the options we’ve discussed so far, simply improving your credit score is probably the wisest choice. Credit repair doesn’t always take a long time. In fact, if you follow these credit repair guidelines, you’ll discover that you can increase your credit score over 100 points in a couple of months.
3 Ways to Fix Your Credit for a Mortgage Loan
1. Request a Goodwill Adjustment
The most important thing you need to deal with before getting your mortgage loan is removing negative items from your credit report. This can greatly increase your credit score. Carefully look over your current credit report to find any negative items such as late payments, collections, and charge-offs.
Next, you’ll want to write a goodwill letter to each one of the original creditors for the negative items. A goodwill letter is basically a letter where you explain your situation, why the negative item occurred, and that you’re trying to apply for a mortgage loan. Then you ask them to forgive it and remove the item from your credit report. It sounds strange, but it works. The easiest way to write a goodwill/forgiveness letter is to use the sample goodwill letter I created as a template.
2. Get your Credit Card Balances Under 15%
Another thing that mortgage lenders will take a good look at is your credit card usage. In other words, if one or more of your credit cards are maxed out (or close to it), you need to get these paid down. In addition to paying down individual credit cards so the balance is under 15% of your available credit, you also need to make sure your overall balance-to-limit ratio is under 15%. Use my Balance-to-Limit Calculator to see where you stand.
3. Avoid Applying for New Loans or Credit Cards
It’s important that you don’t apply for any loans such as a car loan or credit cards while you’re in the process of getting a mortgage loan. The reason for this is that whenever you apply for any new loan or credit card it will show up on your credit report as a hard inquiry. A hard inquiry basically means that you’re seeking out credit and it looks bad when you’re in the process of getting a mortgage. Therefore, wait until after you’ve closed on your new house before applying for any other loans.
Lower Your Score to Save on a Home Loan
By waiting a couple of months to get a mortgage and focusing on improving your credit, you’re not only going to end up saving a ton of cash, but you’re also improving your situation for the future.
Lastly, keep in mind that a mortgage loan is a huge responsibility and whatever option you choice, in order to get a loan, will have a lasting impact on your financial wellbeing. Work carefully with your mortgage lender and do your research before making any decisions.