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5 Home Loan Options if You Have Bad Credit

tl;dr

What You Need To Know

  • While bad-credit mortgages don’t exist as a product, some institutions offer products that may be a bit more forgiving toward borrowers with low credit scores
  • Some people with credit scores as low as 500 can qualify for home loans with additional requirements and possibly higher costs
  • Many programs – like Fannie Mae HomeReady®, Freddie Mac Home Possible® and FHA, VA and USDA loans – help people with lower credit scores buy homes

Contents

A home purchase is a big investment, and it’s an investment many people are eager to make. That’s probably because they’re aware of the many benefits that come with homeownership, like building equity, tax advantages and improving their credit history. 

However, for some of us, a good credit score is the thing that’s holding many of us back from buying our dream home. 

If your credit could use some work, there are loan options to help you clear this hurdle. 

Learn more about these mortgage loans, what they involve and what you should know before you take the home buying leap.

What Mortgage Lenders Consider a Bad Credit Score

When a lender is considering a loan approval and setting the loan’s terms, your credit score (aka FICO® credit score) is a vital part of the decision-making process. There are three main credit bureaus, and each of them assigns a different score. It helps to know what each of these scores means to each reporting bureau.

Equifax® uses a range of 280 – 850 and breaks the numbers down like this[1]

  • 280 – 559: Poor 
  • 560 – 659: Fair 
  • 660 – 724: Good 
  • 725 – 759: Very Good 
  • 760 – 850: Excellent 

TransUnion® uses a range of 300 – 850. Here’s the numbers breakdown[2]

  • 300 – 600: F (Poor) 
  • 601 – 657: D (Fair) 
  • 658 – 719: C (Good) 
  • 720 – 780: B (Very Good) 
  • 781 – 850: A (Excellent) 

Experian™ uses a range of 300 – 850 and breaks down the numbers this way[3]

  • 300 – 579: Poor 
  • 580 – 669: Fair 
  • 670 – 739: Good 
  • 740 – 799: Very Good
  • 800 – 850: Exceptional 

While the scores have similar ranges, it’s possible to have a different score with each of these bureaus. 

You may have a 575 FICO® (Fair Isaac Corporation) Score with TransUnion® but a 605 FICO® Score with Experian™ because the bureaus don’t get the same information about your credit background and use. Maybe some of your credit card companies reported your card use to Experian™, but not to TransUnion®. Or perhaps TransUnion® received notice of a charged-off account, but Experian™ didn’t.

Many different scenarios can cause varying credit scores among the three agencies. Lenders understand this and take the fluctuations and individual scoring systems into account when they review your scores. They may even have an algorithm they use to assign you an internal score for an in-house credit assessment.

Given these variables, bad or poor credit can be a relative thing. 

So, what credit score range qualifies as “bad credit”? Well, it depends on the type of loan, the scoring model and even the type of lender you ask. When it comes to home loans, most lenders consider applicants with a score below 580 as a greater risk. Other lenders may want to see scores above 630.

You may see different credit score qualifications for conventional mortgage loans and government-backed loans. Most conventional loans require a FICO® score of at least 620 for approval, while government-backed loans may approve applicants with a 580 credit score.

But don’t get discouraged if your credit score is below a qualifying minimum credit score. You may still be able to qualify for a home loan. 

The Good News? You Can Get a Home Loan With Bad Credit

So-called “bad credit” doesn’t rule you out when it comes to buying a house. However, the lender may offer you a high interest rate mortgage because of the higher risk of default (aka inability to repay the loan) they believe you present. So, you’ll probably end up with a bigger monthly mortgage payment.

Higher risk of default = higher interest rate = higher monthly mortgage payment.

To cover their investment in your home, they will charge you a higher-than-standard interest rate. 

You may still be able to find a mortgage with an affordable interest rate even if your credit isn’t that great. You’ve got options! Plus, if you work on improving your credit score, you may be able to refinance your mortgage (basically swap out your mortgage with a new one) for better terms later on. 

Need Leads? 5 Loan Options for Buying a House With Bad Credit

There are plenty of financial institutions that welcome the opportunity to lend to someone who seems to be worth the risk – even if their credit score is a bit rocky. Friend those lenders and research the programs that are out there to help you buy a home.

1. Conventional loans – Fannie Mae and Freddie Mac

Conventional loans aren’t backed (think: insured) by the federal government. But conforming conventional loans stick to lending rules set by the federal government under Freddie Mac and Fannie Mae.

Fannie Mae – Federal National Mortgage Association (FNMA)[4]

If your credit is less-than-ideal, the Fannie Mae HomeReady® program may be a good fit for you. Review the basic qualifications to see if you’re eligible:

  • Credit score: at least 620
  • Income: maximum limit equal to no more than 80% of the median income in your area
  • Debt-to-income (DTI) ratio: 45% maximum
  • Down payment: only 3% (flexible funding is okay and can include the income of everyone in your household)
  • Other important information: You must live in the home you’re buying and you must attend a homeownership class.

Freddie Mac – Federal Home Loan Mortgage Corporation[5] 

If you’re building your credit or looking for a home loan that qualifies borrowers with less-than-ideal credit, Freddie Mac’s Home Possible® could be an option. Check out the eligibility criteria:

  • Credit score: no lower than 620
  • Income: maximum base income of less than 80% of your region’s median income
  • Debt-to-income (DTI) ratio: no DTI max (but a DTI over 43% may disqualify you)
  • Down payment: as low as 3% (requires mortgage insurance until you have 20% equity in the home, which means no more than 80% of your home’s value is financed)
  • Other important information: You can get a co-signer for the loan, but the co-signer can’t live in the home. The home must be your primary residence. And first-time home buyers must attend a homeownership education course.

2. Federal Housing Administration (FHA) loans[6]

The FHA insures certain home loans, encouraging banks, credit unions and other FHA-approved financial institutions to offer mortgages to people with poor-to-fair credit. You repay the loan over a 15-year or 30-year period, paying a fixed interest rate. To qualify, you need to meet the following criteria:

  • Credit score: To make a 3.5% down payment on a house, you must have a 580 credit score. Borrowers with a 500 credit score will need to make a down payment of 10%.
  • Income: You need at least 2 years of verifiable employment.
  • Debt-to-income (DTI) ratio: Typically, you need a maximum of 43%, including the monthly mortgage payment, but it can be 50% in some cases. The monthly mortgage payment cannot be over 31% of a borrower’s gross monthly income.
  • Down payment: With a credit score of 580 or higher, you can put down as little as 3.5% of the home’s sale price.
  • Other important information: FHA loans require mortgage insurance, and closing costs can’t be higher than 5% of your loan amount. The home you’re buying must be your primary residence. And you can use grants and gift money from family members to help make your down payment.

The Department of Housing and Urban Development (HUD) maintains an online search tool to help borrowers find FHA lenders in their area.

3. U.S. Department of Agriculture (USDA) loans[7]

If you don’t have the money for a down payment and you’ve always toyed with the idea of escaping to the country, a USDA loan may be the right fit for you. You can only purchase a home in an eligible rural area, and there are several benefits to choosing this program, including low interest rates and lenient eligibility criteria:

  • Credit score: To make a 0% down payment, your credit score can’t be lower than 640. People with lower scores or nonexistent credit may still be eligible, but the interest rates will be higher.
  • Income: Your income must fall below the specified amount set by the U.S. government for the area where you want to buy the home. 
  • Debt-to-income (DTI) ratio: Your DTI must be less than 41% of your gross income. And your mortgage payment can’t be higher than 29% of your monthly gross income. 
  • Down payment: There’s no down payment required.
  • Other important information: You must have mortgage insurance, and the home must be your primary residence.

You can purchase a home with a guaranteed USDA mortgage from a financial institution or qualify for a loan directly from the USDA.

4. Department of Veterans Affairs (VA) loans[8]

Veterans, active-duty service members and their surviving spouses may qualify for VA loans.

  • Credit score: The VA doesn’t set a minimum, but lenders do set their own credit score requirements. Lenders usually want to see a credit score of 640 or higher.
  • Income: Lenders look at your income and monthly bills to determine whether you can make your monthly mortgage payments.
  • Debt-to-income (DTI) ratio: The VA doesn’t set a DTI maximum, but mortgage lenders have their own criteria.
  • Down payment: The VA has no minimum down payment requirement, though some VA-approved lenders do.
  • Other important information: The closing costs are low, and the interest rates are competitive. First-time home buyers must pay a VA funding fee that averages around 2.3% of the loan. Even with no down payment, you won’t have to pay for mortgage insurance. Before applying for a VA loan, you need to show proof of service with a certificate of eligibility (COE). Eligible veterans can use their benefits more than once.

Aside from proof of service, the VA doesn’t set many eligibility rules for a VA-guaranteed loan. However, lenders who offer VA loans will have their own set of requirements. Make sure to shop around and compare lender requirements.

5. Statewide and local programs

Many states and local governments sponsor programs to help people buy their first homes. Down payment assistance, help with closing costs, grants and home buyer education programs are a sampling of the kinds of help these agencies and programs offer home buyers. 

The requirements, minimums, maximums and other criteria for these programs vary by state. Contact your local or state housing authority to find out what’s available. 

How To Get a Home Loan With Bad Credit

Now that you’re more familiar with some of the programs that help people with bad credit qualify for a home loan, check out these tips to boost your chances of eligibility:

  • Research lenders in your area and identify those that are willing to work with borrowers who have bad credit.
  • Apply for first-time home buyer programs and down payment assistance programs to boost the amount you can put down. The bigger your down payment, the better your chance of approval – even with bad credit.
  • Ask family for help with your down payment.
  • Talk to family members or close friends with good credit about the possibility of co-signing your mortgage loan.
  • Plan to pay off your existing debt as quickly as possible before applying for a mortgage.

Finally, ask yourself how soon you want or need to buy a home. Would it be a better plan to concentrate on improving your credit first? Once you’re ready to jump onto the homeownership bus, compare options to find your best home loan opportunity.

Should You Get a ‘Bad-Credit Home Loan’ or Wait?

Owning a home instead of renting can be a smart, wealth-building option for many people. Under the right circumstances, a home’s growing equity can help you build a secure financial future. 

But before you take the leap, you should ask yourself:

  • Why is my credit score low? Do your credit issues come from ballooning debt or having trouble paying bills? Getting a handle on these problems can reinforce better financial habits. Sound financial decisions and good credit behavior may lower the risk of future default on your home loan.

When your credit needs work, you may have to weigh whether now is the time to buy a home or build your credit. 

If you decide to move forward and have been approved for a home loan with bad credit, consider this:

  • Will the mortgage payments exceed 30% of your monthly income? If you follow the 28/36 rule, you should be spending no more than 28% of your gross monthly income on mortgage payments. Spending more than can put you at higher risk of making late payments or not being able to pay your loan back.
  • Does the loan estimate come with a very high interest rate? Research current home loan interest rates and compare them to your offer. If you worked on your credit score, could you get a better (read: lower) interest rate? A boost in your credit score could potentially save you thousands of dollars over the life of the loan.

Pressing pause on a home purchase to improve your credit score (even by a little bit) can potentially have a big impact on the types of loans and interest rates you’ll qualify for. Aim to reach the qualifying credit score of the loan you’re considering. And guess what else you can work on while you’re working on your credit? Your down payment. If you can, grow your down payment while you build your credit. 

All of these improvements can help you qualify for a home loan that comes with a lower interest rate and better terms for you (and your wallet).

  1. Equifax®. “What are the Equifax credit score ranges?” Retrieved September 2021 from https://www.equifax.com/personal/help/equifax-credit-score-ranges/

  2. TransUnion®. “What is a Good Credit Score Range with TransUnion?” Retrieved September 2021 from https://www.transunion.com/article/what-is-a-good-credit-score

  3. Experian™. “What Are the Different Credit Scoring Ranges?” Retrieved September 2021 from https://www.experian.com/blogs/ask-experian/infographic-what-are-the-different-scoring-ranges/

  4. Fannie Mae. “Eligibility Matrix.” Retrieved September 2021 from https://singlefamily.fanniemae.com/media/20786/display

  5. Freddie Mac. “Home Possible®.” Retrieved September 2021 from https://sf.freddiemac.com/working-with-us/origination-underwriting/mortgage-products/home-possible

  6. Federal Deposit Insurance Corporation. “203(b) Mortgage Insurance Program.” Retrieved September 2021 from https://www.fdic.gov/consumers/community/mortgagelending/guide/part-1-docs/203b-mortgage-insurance-program.pdf

  7. USDA Rural Development. “Single Family Home Loan Guarantees.” Retrieved September 2021 from https://www.rd.usda.gov/sites/default/files/fact-sheet/508_RD_FS_RHS_SFHGLP.pdf

  8. U.S. Department of Veterans Affairs. “VA Guaranteed Loan.” Retrieved September 2021 from https://www.benefits.va.gov/BENEFITS/factsheets/homeloans/VA_Guaranteed_Home_Loans.pdf

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In Case You Missed It

Take-aways

  1. Both conventional loans and government-backed mortgages have programs that allow borrowers with bad credit to qualify for home loans
  2. When applying for a home loan with bad credit, other factors – like your down payment, your income and your debt – can help offset your low credit score
  3. Just because you can get a home loan with bad credit doesn't mean you should! Consider working on your credit and your down payment before you buy a home

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