Finding out your credit is poor does not mean you suddenly turned from a good person to a bad person. The thing with bad credit is, it can make life a little more frustrating, but it is manageable. First off, with a lower credit score you will find it will be harder to be approved for loans and credit cards. If you are approved, you are faced with high interest rates and fees.
If you have this much trouble getting a credit card, then you may want to give up on the pursuit of purchasing a home. However, there is no need to turn your back on becoming a homeowner. There are ways to have bad credit and get a mortgage.
What is bad credit?
There are different meanings to bad credit depending on who you ask. This is because you have more than one credit score. Each one will use different models to determine your score. Usually though, you can expect lenders to make determinations based on your FICO credit score. If you are wondering, this is how credit scoring breaks down according to the credit reporting agency Experian:
- 800 or higher: Exceptional
- 740-799: Very good
- 670-739: Good
- 580-669: Fair
- 579 or lower: Very poor
A score of 620 is usually considered the cutoff point for securing a mortgage with traditional lenders. Unfortunately, if you have a score under 580 that means you might be too far down at the moment and most likely will not be approved for a loan. But you can keep working at it and try to bump that number up.
Lending options for those with bad credit
You can get a mortgage loan by going through a private lender. You will have to endure a high interest rate and will most likely need to put down a higher than normal down payment. Be careful about getting drawn into loans that are structured in a way that gives you a loan today but will become unaffordable in a few years when the rates on the loan automatically adjust.
Look into a Government-backed loan
A Federal Housing Administration (FHA) loan may work for you if you have a credit score under 620. You may be able to find a loan where you are only required to put 3.5 percent down. The downside however, FHA loans have a requirement for you to pay 1.75 percent in mortgage insurance. There will also be private mortgage insurant (PMI) payments ranging from .45 to 1.05 percent monthly for the duration of the loan.
More cash can down can help
You can offset the risk a lender is giving you with a loan by putting more money down. By offering 20 percent down, you may not only have a better chance at getting a loan, but you will have a lower monthly payment.
Adjust your debt-to-income ratio
Lenders will look hard at your debt-to-income (DTI) ratio when considering a loan. This ratio determines how much of your income is used to pay debt every month. Typically, lenders want a DTI to be at 43 percent or lower. However, 36 percent is ideal. When your ratio is lower, you are more attractive to loan borrowers. If your ratio is too high, you should consider either raising your income or paying off debt.
Get a co-signer
Enlisting a co-signer basically lets you use that person’s good credit. But this is an important decision that should not be taken lightly. A co-signer will be just as responsible for payments being made as you are, even though your name is on the mortgage. If payments are not made, a co-signer can have their credit damaged.
If you have bad credit and want to get a mortgage you may be facing an uphill climb, but it is doable. You should work with a financial professional for guidance to make sure a mortgage you are taking on makes financial sense.