If you have bad credit, you might assume that you cannot get a home loan. You might be pleasantly surprised, then to learn that it’s not as hard as you think. While you might not qualify for conventional financing with the best interest rates, there may just be a loan out there for you.
The secret is knowing how to find them. First, though, you have to know just how bad your credit really is. You might assume it’s ruined and learn that you have an ‘average credit score.’ You may also find that your score is as low as you thought, and you have some work to do. Knowing what you are dealing with is half of the battle.
Look at Your Credit
The first step is really to look at your credit. You have access to your free credit report once a year from all three credit bureaus. If you think you have bad credit and you want a home loan, now would be the time to pull all three reports. This way you can see just what is reporting and determine any steps you must take.
Look closely at your report. What is making your score drop? Is it:
- Late payments
- Overextended credit
Each of these issues has its own way of rectifying it. For example, late payments you can just bring current. Your score won’t improve overnight, but with regular timely payments, it will steadily increase. If you have collections, you may have to pay them off, but do so with help. Just paying the collection isn’t enough. The collection agency has to agree to report the debt as paid in full in order for your credit score to improve.
If you have a bankruptcy or foreclosure, you will have to wait the required waiting period for the loan program you want. For example, FHA loans require that you wait 2 years after a bankruptcy discharge and three years after a foreclosure. During that time, though, you can start working on improving your credit score.
Apply for an FHA Loan
Once you fix your credit to the best of your ability, it’s time to shop for a loan. We recommend that you start with FHA loans. They have some of the most flexible underwriting guidelines. Typically, they require a 580 credit score and a 31/43 debt ratio. This is fairly forgiving compared to conventional loans which require a 680 or higher credit score and 28/36 debt ratios.
As you look for an FHA lender, keep in mind that each lender has different requirements. Each FHA approved lender must follow the FHA’s minimum rules. But they can also add their own requirements. For example, they can require a 650 credit score rather than the 580 the FHA allows. They can also require lower debt ratios or add other requirements. Shopping around will likely provide you with different requirements from each lender. Keep shopping until you find the lender that fits your needs.
Look at Other Home Loan Options
FHA loans aren’t the only option for borrowers with bad credit, though. You can also try the VA or USDA program, but in order to be eligible for either one, you must meet certain requirements:
- VA loan – You must be a veteran of the military, Reserves or National Guard. You must meet the time served requirements as well. For example, members of the military generally must serve at least 90 days during wartime or 181 days during peacetime. Members of the Reserves or National Guard must serve at least 6 years in order to be eligible.
- USDA loan – In order to qualify for a USDA loan, your household income must not exceed 115% of the median income for your area. This program is reserved for low-to-middle income families that live in rural areas. But the USDA rural areas guidelines offer differ from what you might consider rural.
The VA loan doesn’t have a minimum credit score requirement – they just require ‘decent credit,’ which could work in your favor if you have a score lower than what conventional loans allow. USDA loans do require a minimum 640 credit score, but again, this is lower than conventional lenders require.
One final option if none of the above work would be a subprime lender. Even though these lenders have negative annotations tied to them because of the housing crisis, they are a viable source for a loan, especially if you have bad credit. Many lenders call themselves ‘alternative lenders,’ rather than subprime. Either way, these lenders keep the loans on their own books, so they ‘call the shots,’ so to speak. For some lenders, this could mean providing you with a loan even though you have a lower credit score.
Your best bet when applying for a home loan with bad credit is to try to fix your credit first. This way you have more options when it comes to finding a home loan. Once you fix your credit to the best of your ability, you can try any of the above loan options. Remember, even after you choose a loan program, it’s best to shop around with at least three lenders so that you can find the lender that offers the best rate, closing costs, and terms for your home loan.