If medical bills, divorce or other life circumstances have sent your credit score south, securing a home mortgage may seem out of reach. But a bruised score does not have to confine you to rentals for the foreseeable future. There are still opportunities for low interest rate loans for bad credit.
Mortgage lenders typically rely heavily on credit scores to determine a prospective borrower’s qualifications for a mortgage loan.
Credit scores provide lenders with one of the few available snapshots of how well you have handled credit in the past, which is commonly seen as the best indicator of future repayment reliability.
Generally, credit scores are ranked as follows:
If you don’t already know your credit score, you can claim your free credit report once a year from annualcreditreport.com and receive your credit score for only a small additional fee. Once you receive your report, fix any errors and ask a lender for advice on addressing any issues that can have a quick impact on raising your score.
Be patient. Depending on your situation it could take several months or even upwards of a year before you can push your score high enough to qualify for some of the better interest rates on a conventional loan.
The most critical factor for your mortgage loan is your credit score. They may not seem like much, but even small differences in interest paid on a mortgage loan can add up to hundreds of thousands of dollars over the lifetime of the loan.
The lower your score, the higher your interest rate, but of course the reverse is also true. On a loan as large as a mortgage, a mere percentage one way or the other can add up to a significant amount of money. It is not unusual to find the interest rates offered to the highest and lowest credit score tiers vary by as much as a full percentage point and a half.
According to myFICO.com, the difference in the monthly payment on a $300,000 mortgage between the lowest and highest scores can be as high as $300. Over the course of a 30-year mortgage, that can add up to an astounding $100,000.
Before the housing market meltdown of a few years ago, borrowers could get a home loan without a lot of effort, often without even providing documentation of their assets or income.
While they often charged substantially higher interest rates, there were plenty of subprime lenders who would approve loans for borrowers with low credit scores. But times have changed. Most subprime lenders went out of business, but that doesn’t mean you are automatically prohibited from qualifying for a home loan.
The Federal Housing Administration’s loan program is the most common loan product available for prospective borrowers with credit scores on the low side. This type of loan is insured by FHA to protect against potential loan default. It requires a minimum credit score of 580 with a down payment of 3.5 percent.
While that may sound good, keep in mind that despite FHA’s requirements, most lenders will still want a credit score of 620 to 640 minimum for FHA loan approval.
You will also be asked to supply documentation of your income and assets. The lender will use these to determine if you meet debt-to-income ratio requirements, which typically call for a maximum of 41 to 43 percent of your monthly gross income applied as the minimum payments on all your revolving and installment debts.
While you may be able to qualify easier than you could with a conventional loan, the drawback is that an FHA loan has higher mortgage insurance requirements. In addition, these payments are required throughout the entire lifetime of the loan unless you are able to pull together a more substantial down payment.
However, despite having somewhat lower credit score requirements, FHA mortgage rates are comparable to those of conventional loans, so if you go the FHA loan route, you aren’t stuck paying a higher interest rate for the next 30 years.
Even borrowers with significant credit blemishes, like short sale or bankruptcy, may be able to meet requirements for getting a mortgage. FHA’s “Back to Work” program allows borrowers to reduce the waiting period to qualify for a home loan.
There are certain requirements to quality, such as receiving financial counseling. You lender should be able to point you in the right direction to determine if you could qualify.