While a 20% down payment and a great credit history are commonly recommended for buying a home, there are still ways you can be approved for a mortgage without them. The secret is finding your personal strengths as a potential homebuyer and overcoming your weaknesses.
Good and Bad Credit for a Home Loan
Getting a home loan with bad credit can be daunting. But even credit scores traditionally thought of as “bad” won’t stop you from being approved for a mortgage.
Credit Score Scale for Mortgage Approval
|620–680||Less than perfect, but still approvable for a home loan|
|550–620||Needs improvement before applying|
|300–550||Unlikely to be approved for a home loan|
If you have a score lower than 620, it’s unlikely you’ll be approved for a home loan. Take some time to improve your credit by paying debts on time before you apply for a loan. And while you may be approved for a mortgage with a credit score between 620 and 680, such a score will affect your loan program and pricing.
Effects of Bad Credit on a Home Loan
Your credit score determines two major things for a mortgage company: the loan program and pricing.
There are various types of loan programs, including conventional, Federal Housing Administration (FHA), and Veterans Affairs (VA) loans. There are advantages and disadvantages to each of them. But unless you’re a US veteran or service member, or married to one, you won’t have access to VA loans.
Conventional loans are best for borrowers with good to outstanding credit, but if you have a large down payment, you might be approved for one even with bad credit. On the other hand, FHA loans are accessible to people with less-than-perfect credit scores, but these loans tend to come with higher expenses.
When it comes to pricing, your mortgage interest rates will most likely be higher than those of someone with good credit. You may also face additional premiums and more expensive insurance.
Your credit history is another determining factor in whether your loan will be approved or not. Derogatory items, or negative indications on your credit report, such as patterns of previous credit delinquencies and balances on closed-out accounts will negatively affect your mortgage loan approval.
Lenders will look at credit scores first to determine which home loan you’re eligible for. Next, your complete credit overview, including credit history, will be taken into consideration to determine what the lender will look for in the underwriting process. This is when the lender tries to figure out what happened in your credit history and why, as well as if there’s a chance credit issues will occur again in the future.
Overcoming Common Credit Red Flags
These derogatory items will be a cause of concern for lenders—but may not be total deal breakers:
- Patterns of Delinquencies: Lenders can work around a record of late payments, but they’ll likely require you to have a larger down payment and lower debt-to-income percentage.
- Student Loan Late Payments: A late federal student loan payment within the past 12 months will make approval less likely for an FHA because government financing doesn’t take kindly to delinquent federal debt.
- Mortgage Late Payments: Lenders usually overlook one late payment in the past 12 months, so long as you can explain and provide necessary documentation.
- Foreclosure: After a foreclosure, it takes 36 months to be eligible for a 3.5% down FHA loan and 48 months for a no-money-down VA loan. However, it takes seven years to qualify for a conventional loan approval, no matter the size of the down payment.
- Short Sale: Mortgage eligibility after short sale is 36 months for a 3.5% down FHA loan and 24 months for a no-money-down VA loan or a 20% down conventional loan.
- Bankruptcy: With normal Chapter 7 bankruptcy you have 24 months until you’re eligible for a 3.5% down FHA loan and 48 months for a VA loan or conventional loan.
To determine which red flags to overlook, lenders use investor overlays. These are the guidelines mortgage brokers and banks follow to prevent potential mortgage losses.
Investor overlays vary from lender to lender, so while one lender might not approve your loan because of poor credit and a minimal down payment, another may in some instances. The key is to find a lender with minimal overlays who can work with your situation.
Not sure where to start looking for a mortgage? At Credit.com, we offer a helpful list of mortgage rates from lenders in your area.
Second, gather documentation to explain your credit challenges. If you can explain derogatory items in your credit history to a lender, you’re more likely to receive a mortgage.
Finally, be very specific when speaking to a potential lender. Don’t be afraid to share every detail of your needs and concerns. You’ll save yourself a lot of headache later by finding out up-front if they have any investor overlays that could prevent them from lending to you.
You don’t have to have perfect credit to buy a home. Just be prepared and search carefully for the lender who can make your dream home a reality.