The statistics recorded by the Census Bureau show a rising trend within homeownership since 2016. Interestingly, 56.3% of all the housing units in America belong to the people living there. People aged 55 and over own more than half of those homes. Logically, the smallest percentage of owned properties belongs to the millennials, the ones under 35 years old.
The people who were born after 1984 had to struggle with the financial crisis, recession, and challenging economic situation. In such complicated circumstances, saving for a substantial down payment and an affordable mortgage loan turns out to be quite the challenge. Bad credit doesn’t contribute to simplifying the situation. Even if you enjoy a comfortable lifestyle, a young person’s credit rating is bound to be lower just because of thin credit history.
For everyday purposes, one might overlook their bad credit. However, a mortgage loan lender won’t. No matter what the reason for a bad credit score is, there are several options on how to borrow money at relatively affordable rates. We prepared for you an overview of the existing alternatives accompanied by explanations of some of the frequently used terms in the field.
Poor Credit Score? How Bad, Indeed?
You have been late with paying loan installments, your debt keeps on revolving, or you are missing out on minimum credit card payments. These are all reasons to believe that your credit rate scores on the lower end of the spectrum. But how sure are you in reality? First things first: get acquainted with your credit report. You can request a free report from annualcreditreport.com.
Three companies monitor citizens’ credit activities—Equifax, Experian, and TransUnion. Each one of them must provide you with your credit report for free once per year. You should be able to access your report immediately if you request it online. Have a detailed look at the credit statement, since mistakes and inconsistencies are not uncommon. Incorrect data might hurt your score. The good news is that you can contact the company that does your credit report as well as your credit provider and dispute any inaccurate information.
What Counts as Bad Credit?
Banks, credit card providers, and other financial institutions need to access your creditworthiness before they decide to lend you money. They evaluate the probability of your paying them back on time or eventually defaulting the loan. Otherwise said, the credit score represents your creditworthiness. Based on that, lenders decide the maximum amount you can borrow, how long until you repay the debt, and what the interest rate will be. Most lenders use the FICO score. However, more assessment tools exist on the market.
FICO score is a number between 300 and 850. It illustrates the information in the credit report. Generally, financial institutions consider any person with a rating of 670 and over to represent less risk for their money. However, each creditor has different requirements based on the offered product. Here is an explanation of what the FICO numbers mean.
<580 = Poor Rating
Your credit is below the nationwide average score. You are a risky borrower. You might find it defined as “subprime” and as “deep subprime” if below 549.
580-669 = Fair Rating
Your credit is below the nationwide average score. However, some creditors will agree to lend you money. If you are on the lower end of the range, you might still be qualified as a “subprime.” If your score is higher than 620, you are within the “nonprime” tier.
670-739 = Good Rating
Your score is around the American average. Such a rating is enough to qualify you for credit. Also known as “prime” credit rating.
740-799 = Very Good Rating
Your score is above the U.S. average. Lenders will consider you as a reliable borrower. A score of 740+ falls in the “super prime” category.
800+ = Exceptional Rating
Your credit score is substantially above the nationwide average. You will enjoy a trouble-free credit process with considerable perks.
Minimum Credit Score for Mortgage Loan
A National Mortgage Database’s report shows that more than 75% of borrowers in 2016 had a prime or super-prime credit rating. Almost 20% belonged to the “nonprime” tier, with scores between 620 and 679. If you are one of those people with a fair-to-poor credit score, don’t get desperate. Although statistics are not on your side, there is still hope. About 6% of mortgage borrows had a subprime credit score.
One thing that the study indicated is that people with a rating lower than 620 lack knowledge and confidence about mortgage loans. They fall behind when it comes to credit conditions such as interest rates, mortgage types, and closing costs. Moreover, borrowers with bad credit loans are significantly more concerned about qualifying. They don’t have a firm idea about the kind of mortgage wanted. Do you recognize yourself? If the answer is affirmative, keep reading and get familiar with homeowners’ loan basics, especially when you are looking for the best mortgage lenders for poor credit.
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Foremost, let us answer the question of how conventional loans function. If you have made up your mind to buy a house, one of the first things to do is to estimate what is your current financial situation. How much money do you have in your savings account that you can put toward a down payment?
Generally speaking, the higher the amount, the better the loan you would get. The credit score comes next. It has a significant impact on the creditor’s decision to lend you the loan, and it influences the concrete offer. If you are one of those prime or super-prime borrowers, you will enjoy lower interest rates and probably fewer closing fees.
The interest represents the costs you have to pay to the lender for borrowing money from them. Currently, interest rates are at historically low levels. Still, it isn’t cheap. Let’s say you are buying a $200,000 property with a 20% down payment or $40,000. Your loan is for 30 years and gets a 4.15 % APR. According to MyFico Calculator, you will pay $119,996 in interest.
If it isn’t clear by now, the lower your creditworthiness, the higher interest rate the bank will offer you. It means that if you have a weaker credit score, the APR rises. If we take the example from above with an APR of 5%, the interest costs jump to $149,209. Note that an even less than one percent increase adds up to an almost $30,000 difference over time!
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Bad Credit Home Loans
There are subprime mortgage lenders that are willing to overlook a less-than-perfect credit. Before you get excited, be aware that the creditors will consider you a very risky borrower. Thus, they will offer you very unfavorable conditions, including high APR rates and pricy closing costs. Unless you find yourself in an extreme situation, it is best to think twice before agreeing to such a poor credit loan.
In this case, waiting is a good strategy. In the meantime, you should work to improve your credit score, so that you can benefit from better conventional loans. If you go with such credit, you might end up worsening your debt situation instead of achieving some level of financial security. You might think that budgeting for a baby or experiencing a recent foreclosure is reason enough to sign up for conventional subprime loans. Take a look at some of the alternative loans described below and reevaluate your situation.
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Federal Housing Administration (FHA) Loans
FHA mortgages are government-backed loans. While the Department of Housing and Urban Development doesn’t distribute the money directly, it guarantees the mortgage loan to a private lender. The risk to the creditor decreases, and they can offer more agreeable conditions to the borrower.
Even with bad credit, you won’t be asked to provide a considerable down payment. Moreover, the interest rates won’t rocket to the sky. FHA loans are not cheap, but still, they are an affordable option for those who don’t have the comfort of a good credit rating.
With a minimum credit score of 580, you can get a loan with a down payment as low as 3.5%. This means that the upfront payment for a $150,000 home will amount to $5,250. Even with a score ranging between 500 and 579, you can still qualify for an FHA mortgage. However, the government requests that you provide a 10% down payment in such a scenario.
Since the government only ensures the credit, the lenders are the ones who have the final words. They might set up different FHA mortgage rates regarding the minimum credit rating and the size of the down payment.
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Similarly to FHA loans, the VA mortgage features government-backed loans provided by private creditors. The Department of Veteran Affairs manages the program. It has been in function since 1944 and aims to lessen the financial burden for U.S. active-duty military members and veterans when purchasing a home. Creditors providing a VA loan usually don’t ask for a down payment. There is no minimum credit score required to qualify for a VA loan. The lender should consider the overall financial situation of the applicant.
However, most creditors set their requirements of a 640 score. VA loans have even more advantages. There is no insurance required, and the closing costs are lower. However, you need to provide a Certificate of Eligibility to qualify for a VA mortgage. Both VA and FHA loans have strict rules regarding the amount of the borrowed money. They are programs designed to support people in tough circumstances and not necessarily to help you purchase your dream house. If you or your spouse qualify for a VA loan, here are the best VA lenders for 2019.
The U.S. Department of Agriculture designed loans to support low-to-moderate income families to obtain a home in rural areas. Borrowers with subprime credit status won’t qualify since the minimum credit score required is 640. Creditors don’t request upfront payment; however, the interest rates might be slightly higher. The USDA loans are attractive because rural doesn’t necessarily mean living in the wilderness. Take a look at the eligibility map to get a comprehensive understanding of the territory in question.
Fannie Mae and Freddie Mac
Buying a home is considered an investment. Creditors who provide mortgage loans are risking less. At the end of the day, if you can’t meet your mortgage payments, the property stays with the lender. However, real estate is not the prime business of banks and other credit lenders. After closing a mortgage and making sure that the borrowers pay regularly, the creditor will most likely sell the loan to government agencies such as Fannie Mae or Freddie Mac. Thus, the creditors operate with more money to lend, and at the same time, the number of homeowners is increasing.
Fannie Mae and Freddie Mac are the agencies that set the standards in the area of mortgage loans. Both operate specific programs to support customers with bad credit. Fannie Mae’s Home Ready program sets the minimum credit score at 620, while Freddie Mac’s Home Possible expects at least 660.
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Recent Foreclosure or Bankruptcy Consequences
Both foreclosure and bankruptcy are events that have a substantial negative impact on your credit score. However, even in that situation, there are loan options. If you go with Fannie Mae’s or Freddie Mac’s programs, you will deal with more extended waiting periods. You would have to wait seven years after the foreclosure and between two and four years after the bankruptcy discharge.
FHA, VA, and USDA loans are considerably less strict in that area. In cases of foreclosure, you will have to wait between two and three years until applying for a mortgage loan. For bankruptcy, the period ranges from 12 months to three years. Within this time, you are encouraged to improve your credit score and meet all the needed requirements for obtaining a loan.
How to Improve Your Chances
Besides a lousy credit score, your situation might include a lack of secured finances for a down payment or a revolving debt situation. The lack of knowledge also hinders the process of obtaining an affordable mortgage. No matter what is your case, there are mortgage mistakes that you should avoid. On the other side, some steps will improve your situation for sure, regardless of how challenging they seem.
Fannie Mae offers HomePath Ready Buyer Course. The training costs $75, and the fee is refundable once you apply for the mortgage. The website claims that it takes up to several hours to get through the course, and you can do it in times that best suit your schedule. Besides, boosting your knowledge of how mortgages work, you can also request a 3% discount on closing costs and fee reimbursement once you finish the training and apply for a mortgage.
Do Your Research
Do your homework and compare lenders and their offers. If you decide to consider only one creditor, you are voluntarily refusing your right to choose from the open market. Compare mortgage rates of several lenders before you make the final decision.
Improve Your Credit Score
Credit bureaus monitor a couple of things when assessing your credit score. They follow whether you are regular on your monthly payments. Revolving balance contributes a lot to lower your score. Your credit utilization is another significant factor.
There are simple steps to overcome debt and save money. Most importantly, make only as many credit card purchases as you can afford to pay within the grace period. That is how you avoid paying interest. It will reduce your current balance if you have one. Making the regular monthly payments on time also shows to creditors that you are a reliable borrower. Financial consultants will advise you to aim at 7% credit utilization, but anything below the 30% line is good enough. If your credit limit is $10,000, you shouldn’t spend more than $3,000 a month.
Finally, if you are on the path of improving your credit rating, you should avoid closing your accounts. This action will influence your score negatively. The same goes for opening new credit card accounts or loans unless it is an action within debt management or debt consolidation plan.
Explain Your Situation
If your credit payment history shows some ups and downs, try to provide documents explaining them. A substantial credit card balance may be due to high medical bills that you are on your way to pay off. Maybe you have been unemployed for some time, but you just landed a stable job with regular payments. Besides the contract, a letter from the employer might make your case stronger. Your secured employment is a sign of a higher chance of monthly payments on time. If your debt is due to a student loan that paid for your college, prove that you have a plan to pay the remaining part.
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Aim for Higher Down Payment
Buying property means not only providing yourself and your family with a home, but it is also an investment. Most people cannot afford to buy a house in a single transaction, hence the existence of a mortgage. However, whatever you put upfront is already yours. Moreover, it shows the creditor that you are serious about purchasing the home. If you have a bad credit score, a higher down payment might cause the bank to overlook your credit history and agree to lend you the money. It will undoubtedly contribute to achieving more favorable conditions in terms of interest rate and fees. However, don’t be unreasonable. You don’t want to scrape off your emergency fund or to be left out without money for home insurance in case a tree falls on your roof.
Not Enough Savings?
If your savings are not enough to cover a substantial down payment, look for programs that assist first-time buyers in your state. There are charities and state programs that provide money for a down payment to young families that fall within specific criteria. Asking relatives to help you out with some gift money is also a good idea. Another option is to sell items that you don’t need anymore. Don’t forget about your savings for retirement—check if you can take out some cash now and put it back later on.
Properties are considered investments because of the possibility of increasing their value over time. If you put $20,000 down on a $200,000 home, you end up with a mortgage debt of $180,000. In time, the real estate prices rise, and your home costs $230,000. It means that the equity of your home is $50,000. It will be even more because, in the meantime, you have paid some part of your principal of the mortgage.
You can use the value that your home built up to make some cash. However, you use your home as collateral, so it poses a risk of losing your property. There are two ways to use the equity of your house to raise money—a cash-out refinance loan or home equity loan. Keep in mind that the idea behind any refinance loan is to end up with better conditions. If your credit score is low, you will probably have difficulty achieving that. However, refinance loans might serve as a source of cash if you are in need.
Cash-Out Refinance Loan
Cash-out refinance loan means to get a new mortgage that covers the size of your old debt. However, due to the increased value of your house, you can take a larger loan. Whatever is left after you cover the old debt is money that you can use for your own purposes. Needless to say, such a refinance loan prolongs the period until you pay off your house entirely. It will also cost you more money in the long-run, so do your financial planning well.
Home Equity Loan
The difference with the home equity loan is that it is separate from your original mortgage. It uses the value of the property as collateral, the same as a cash-out refinance loan, but you keep paying your old mortgage. Once you pay off your home equity loan, you can’t get another one. While with the home equity credit line, you can always use money from the credit as long as you pay it back.
Mortgage Glossary and Things to Pay Attention To
Mortgage terms, abbreviations, and some small catches might make the process of shopping for homeowners loans a bit of hustle. We want to help you avoid it, so here are some additional essential phrases to master.
Private Mortgage Insurance (PMI)
Commonly, mortgage lenders demand from the borrower to pay mortgage insurance unless they come up with a 20% down payment. It serves as protection for the mortgage provider against default on loan. The lower the down payment is, the higher the insurance rate is. You could pay the PMI in the beginning as part of the closing costs, or you can ask your creditor to include it in the mortgage payments. PMI is also applicable for FHA and USDA loans.
When you divide the amount of the loan by the value of the house, you can estimate the loan-to-value ratio of the mortgage loan. If the property costs $100,000 and you took out a mortgage of $93,500, the LTV is 0,935 = 93.5%. The rule goes that when the LTV is lower, the risk for the creditor also decreases.
Debt-to-Income Ratio (DTI)
The debt-to-income ratio is almost as important as your credit score when applying for a mortgage loan. It represents the relation of your debt to your income. If you have a low DTI, you will find it easier to convince a creditor to lend you money. After all, the ability to handle money and to build a budget is what counts here. Typically, lenders see a DTI less than 50 % as acceptable; however, don’t count on it for a done deal. VA loans prove to be more tolerant of borrowers with DTI scoring as high as 60%. FHA loans, on the other hand, demand a DTI rate of 43% accompanied by a 580 or higher credit score.
Fixed-Rate Mortgage and Adjustable-Rate Mortgage
Fixed-rate loans have fixed monthly payments based on the APR rates. The adjustable-rate mortgage is what the name suggests—the interest rate changes over time. For a specified period, the payments are fixed. After that, the creditor adjusts the payments regularly based on the current economic situation. The lenders and the borrower agree in advance about the initial period and the frequency of readjustments. A 4/1 ARM signifies a mortgage with a fixed payment rate for the first four years; in the following period, the adjustments happen once a year.
The ARM has its perks with the lower APR in the initial period being the highlight. An ARM mortgage is suitable for somebody with bad credit who is positive that their rate will be significantly better after the initial period is over. By that time, the borrower will have the opportunity to renegotiate the mortgage conditions and even refinance it. Of course, there is a considerable downside. In case your plan fails, the interest rates will most likely rise significantly.
If you are considering ARM or refinance loans on your mortgage, make sure there is no prepayment penalty clause first. Some lenders charge you a fee for paying off your mortgage as a whole or a substantial part of it. Commonly, such provisions function within a defined period—i.e., three to five years. If there is a prepayment penalty, read the fine print carefully.
Confirm with a consultant that you correctly understand the conditions under which the creditor will charge you. If you receive a mortgage quote with such a clause, ask the debt provider to send you a similar offer without the close. That will give you the possibility to comprehend the difference.
When you are purchasing a property, there are certain expenses, taxes, and fees to be paid for the transaction. The most common ones include an appraisal, homeowners insurance, government taxes, property taxes, tax service provider, title insurance, etc. Usually, the buyer is the one to pay the closing costs, which add up with the down payment and all the expenses needed for the actual relocation and renovation (if required). When cash is short, the borrower could ask the creditor to add the costs to the loan. However, this only makes the mortgage more expensive.
Choice of a Credit Provider
The mortgage market offers a wide variety of lenders. It is up to you to decide whether you sign a loan with a bank, credit union, or through a mortgage broker. What is the difference?
Brokers do not lend money. They are the connection between the customer and the creditors and their products. The advantage of working with a broker is that you get someone to do your research. The broker will get to know your situation and, based on that, will look for different mortgage quotes to present. They might consult you, but the final choice lies with you. Since 2008, brokers need to pass an exam to obtain a license as part of the SAFE Mortgage Licensing Act.
There are a couple of drawbacks, though. You can’t be sure that the broker shows you the offers that are best suited for you. They might be promoting only the ones coming from partner lenders. Another disadvantage is that it is expensive. Make sure from the very beginning to clarify who pays the broker fee and how much it will cost. Another tip is to have a contract with the broker. It should clearly state that the broker is working in your best interest. Once you have your mortgage, you will be communicating directly with the credit provider.
Banks and Credit Unions
Banks and credit unions are considered direct lenders. Most of the mortgage loans are a product of direct communication between the bank/credit union and the borrower. Working with the lender itself means lower costs. You are dealing with an employee of the financial institution. Thus, you are not paying an hourly fee for the consultation.
Moreover, an employee might offer you an in-house credit product that is not sold through brokers. The disadvantage is that there is no variety. You will get offers only within the institution. If you want to compare a couple of quotes, you should do it on your own.
In the case of bad credit, credit unions might be the better choice. The difference with a bank is that they are not-for-profit institutions that are owned by their members and exist to serve them. Therefore, credit unions can offer reasonable rates.
Underwriting—Automated or Manual?
The underwriting can go two ways. It could be done manually; otherwise, said people would be reviewing your application and requesting additional data. With the automated option, computers will scrutinize your documents following specific algorithms. Both have their pros and cons.
If your credit situation is complicated and doesn’t look so good in numbers, you had better go with manual underwriting. That way, you could provide additional information explaining the reasons for your bad credit. You could convince the creditor’s employee that you are on the path to improve your credit score. It could be by finding a job, changing to a credit card better suited for bad credit, paying your debt regularly, etc.
Choosing an automated process will be beneficial for you if you have good credit and reliable prospects. The machine considers facts and figures, and if you have that in your application, you will get a quick and probably affirmative answer.
Overview of Creditors
Below you can get familiar with three of the more exciting lenders we found on the market. If you are looking for the best mortgage lenders for poor credit then keep your eyes and ears open. There is an excellent variety of choice of creditors, so we advise you to explore options on your own. Keep in mind that your state might have some special programs to support you in the process. Moreover, some local lenders are better aware of regional characteristics and might offer you a more competitive deal than nationwide represented companies.
As one of America’s leading mortgage lending organizations, Quicken Loans has a full palette of good and bad credit home loans. FHA, VA, and USDA mortgages are available. The company is one of the most experienced online lenders. Through their Rocket Mortgage product, you can apply and follow your loan without talking to an agent or visiting the company’s office. The option to get pre-approved for free can raise your chances when putting an offer on a house.
If you want to get up to five offers for a mortgage loan from different creditors, LendingTree is probably the place for you. The company contributed to the process of loan lenders competing for the customers’ business. The main advantage is that it takes no time. In five minutes, you get your offers, and you can choose the one that fits your needs the best. The service is available for auto loans, small business loans, personal loans, secured credit cards, and others.
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Searching for a home property and applying for a loan on the same day is possible through Vylla’s services. Choose the zip code you are considering and explore the area for homes that fit your criteria. Next, based on your data, the website will provide you with several loans to choose from. FHA, VA, and USDA mortgages are also available with a minimum credit score of 500.
All in All
Buying a home is challenging enough; do your best to understand how the mortgage loans work. Sift through your situation and make a realistic vision for the next 15 to 30 years. When you have this in mind, it will be easier to recognize the following steps to obtain your new home. Even if you experience bad credit, there is a way out through focused and patient work.
Have you ever had to improve your credit score? Tell us what the most decisive steps of the process were!