Article Updated July 17, 2018.
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.
Why do Mortgage Lenders Care So Much About Credit Scores?
Your credit scores and credit files are the primary documents most lenders will use to help them determine if you are a good or bad risk for a loan. It will also give them a better idea about how much they can safely loan to you because they can see it can be paid back and on time.
Your credit scores and credit reports will also show a potential mortgage lenders your credit history and how you have handled your past debt and payment obligations. Do you have several late and delinquent payments? Bankruptcies or other adverse judgments?
Even if you find that you have a good credit score standing above the 750 mark, for example, you should also be aware that a potential lender will also look at the level of debt you currently have and if it is high, they may choose not to extend the loan.
If you have a minimal credit history, however, opposed to bad credit, the lender for the mortgage loan will also be able to look into other areas to determine a borrowers creditworthiness, such as checking utility payment records or rent payment history.
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.
If you find that you have bad credit, then the primary option for you to buy a home would be an FHA loan. If you find that your credit score falls between 500 and 579 and you have at least ten percent available for a down payment, it is a viable option.
You can also save money for a larger down payment. It is worse if the borrowers seeking the mortgage loan have a combination of bad credit and no money down for the home. Down payments make for less risky borrowers in the eyes of the lender.
It is also important if you have bad credit and are trying to secure a home loan, to lower your overall debt-to-income ratio. The debt-to-income ratio is a way to calculate how much the borrower can afford and to make sure that if given the loan, they are not extending themselves beyond their means.
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 or less-than-perfect 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 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 is 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 a Federal Housing Administration loan because government financing doesn’t take kindly to delinquent federal
- 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 headaches 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.
If you want to make sure your credit is ready for you to buy a home, you can check your three credit reports for free once a year. To track your credit more regularly, Credit.com’s free Credit Report Card is an easy-to-understand breakdown of your credit report information that uses letter grades—plus you get two free credit scores updated every 14 days.