Trying to get a mortgage with a low credit score can be difficult and stressful for borrowers looking to buy a home. Oftentimes, those with less-than-ideal credit give up on the idea of getting a mortgage altogether because they believe they won’t get approved. Others with bad credit choose to obtain a mortgage anyway regardless of the high interest rate being charged as a result of their bad credit.
If you’re struggling to pay down debt and have a less than 600 credit score, you might think that the dream of homeownership is out of reach; however, this isn’t always true.
There are options out there for people who are in the process of rebuilding their credit. These options are not often discussed, which is why it’s important to understand what’s out there when it comes to getting a mortgage with bad credit.
What to Do Before Applying for a Mortgage Loan
Many consumers with lower credit scores might be better served by taking some time to rebuild their credit before taking on a mortgage that could come with a high interest rate.
Even if you’re approved with a low score, the chances are that the interest rate on that loan will make the loan unaffordable and could put you in even greater financial danger. Here are three concrete steps that you can take to improve your score within a relatively short period of time.
1. Obtain Your Free Credit Reports
When looking to rebuild your credit, the first thing you should do is have a detailed overview of what is on your credit reports. Those who haven’t checked their credit in over a year can get a free copy from each of the three major credit bureaus— Experian, Equifax, and TransUnion.
Having access to all three is important because each report will have different credit events that the other might not have. Knowing the dings on your credit report can give you a better idea of what can be disputed and eventually removed from your report.
2. Dispute any Negative Marks on Your Credit Reports
Once you’ve received your free credit reports, you can now take steps to remove any negative remarks by disputing those claims. This can be especially effective when dealing with older credit card debt that has many times been sold to a debt collection agency.
Oftentimes debt collection agencies have no way of proving what you owe. This makes it easy for certain delinquent payments to be removed from your report altogether.
After removing any negative marks on your report, there are some other essential steps you should take to get you on the fast track to improving your store. These steps include paying your bills on time, readjusting your budget to prioritize paying off existing debt, as well as charging what you can afford to pay on your credit cards within 30 days.
Some other noteworthy tips are to avoid using more than 15 percent of your available credit and avoid applying for any additional lines of credit.
3. Shop Around for the Best Rates
Once you’ve taken these steps, you can begin speaking to qualified lenders to let them know about your progress. Make sure to shop around for the best rate. If it’s been long enough, taking those steps can significantly increase your chances of getting approved at an affordable interest rate.
The credit rebuilding process can take anywhere from six months to a year, so patience will be key. However, through discipline and consistency, you can improve your score to the point that can make the dream of homeownership attainable.
Having gone over how you can start improving your score before applying for a mortgage, it should be said that this is probably the most efficient way to get a loan. It will prevent you from paying higher interest rates down the road. However, if you need to buy a home in the immediate future, there are options for you even if your credit isn’t exactly where you want it to be.
Mortgage Loan Options for Those With Bad Credit
In this section, you’ll be able to gain more insight into what compromises will need to be made to secure a loan with a low credit score. Ultimately, those with lower credit will need to pay more in interest and fees. However, there are still some notable options.
Apply for an FHA Program
Typically, those who have a FICO score under 650 will not be eligible for a conventional mortgage loan. For the most part, traditional mortgage lenders tend to avoid consumers with scores any lower than 650. Luckily, the Federal Housing Administration (FHA) can help those with less-than-stellar credit.
When applying for an FHA Program, it is important to know that the FHA will not lend you the money for the purchase of your new home. Instead, the FHA simply guarantees a loan that is approved by a lender. This means that they back the loan entirely and will pay the amount owed on the property should the borrower default on the loan.
Getting an FHA-approved loan greatly increases a consumer’s chances of getting approved for a mortgage, but not everyone will be approved. You can see a full overview of the credit requirements for an FHA loan by checking out their website.
Get an Adjustable-Rate Mortgage (ARM)
Those with poor credit who are approved for a conventional loan will likely have a very high fixed interest rate that will make the loan unaffordable. Because this isn’t tenable for most borrowers, the option of an adjustable-rate mortgage (ARM) could be more appealing.
With an ARM, consumers can keep interest payments low for some time which can make payments manageable. However, it is important to note that ARMs carry a fair amount of risk. Because the interest rate can vary from month to month, there is a possibility that the interest rate rises to a point where the payment becomes unaffordable.
With this in mind, it is important to do your research before taking out this type of loan. Here is a list of four potential questions to ask your lender before taking out an ARM loan.
- How much will my interest rate fluctuate with each adjustment?
- How often will my rate go up? And at what point will it go up?
- Is there a limit to how much interest can be charged?
- Are there any caps on how much the rate could increase?
Having an idea of the answers to some of these questions can help you make a more informed decision on whether or not an adjustable-rate mortgage is right for you.
Get a Co-signer
Another option to getting approved for a loan with bad credit is getting a co-signer. Having someone who can vouch for you and be responsible for the loan if the payments are not being made can be a very effective way of getting a mortgage.
If you decide to go this route, it is important to understand that this is a risky option in that it could seriously impact the relationship you have with your co-signer if things were to go awry.
Having a relationship ruined with a family member or friend is not something you should take lightly, especially when dealing with something as important and financially valuable as a home loan. This is why many financial advisors do not recommend their clients to co-sign for friends or family, no matter how close they are.
However, if you decide to take the chance, make sure you feel confident that you can make the monthly payments. The last thing you want is to destroy a close relationship between a family member or friend.
Improve Your Credit Before Getting a Mortgage
While applying for FHA loans or getting a co-signer are certainly viable options for getting a mortgage with bad credit, it cannot be emphasized enough that the best way to go about getting a mortgage loan is to improve your credit.
3 Quick Ways to Improve Your Credit for a Mortgage Loan
Here are three relatively quick ways to get your credit in better shape before applying for a mortgage loan. Spending the time to improve your credit can save you thousands in the long run!
1. Request a Goodwill Adjustment
As mentioned earlier, removing negative remarks from a credit report is crucial when trying to improve your score to get approved for a mortgage. Begin by carefully reviewing your credit reports to find any negative items such as late payments, collections, and charge-offs.
Once you’ve identified the negative marks, you should write a goodwill letter to the original creditors that address each one of the negative items. Goodwill letters are essentially a letter you write to a creditor explaining your situation while giving reasons for why a particular late payment occurred.
In the letter, you should also speak about the steps you’re taking to improve your credit as well as your wish to apply for a mortgage loan. By doing this, you would be surprised at how effectively it can work. In many cases, negative events will be removed from your credit history, which can significantly raise your score in a relatively short period of time.
2. Get your Credit Card Balances Under a 15% Utilization Ratio
Most mortgage lenders will pay close attention to your credit card usage. If you have credit cards that are maxed out or getting close to that point, you will need to pay those down immediately. Make sure to get your total credit card utilization under 15% to have a better chance at getting an affordable home loan.
3. Avoid Applying for New Loans or Credit Cards
One final word of advice to those looking to improve their credit in order to be approved for a loan is to avoid applying for new credit cards or a car loan. Doing this can significantly hurt your chances of getting approved for a mortgage because a hard inquiry will show up on your credit report.
Hard inquiries are not looked at favorably through the lender’s eyes. This is why you would be better off waiting until closing on your house before taking on another loan or credit card.
Takeaway
Having gone over the various steps you can take to improve your credit, as well as how you can get a mortgage without the best credit, the main takeaway is that improving your score before getting a mortgage is usually the best way to go.
While it is not impossible to get approved with a bad score, you will most likely end up paying a higher interest rate which can lead to more financial trouble down the road. Be sure to weigh your options and take all the time you need to prepare for homeownership. You got this!
