Weak Credit? You Can Still Get a Mortgage Despite Tough Lending Standards

By Mikey Rox on 5 October 2017 0 comments

Talk to anyone who bought a house in the mid-2000s and they'll probably relate a painless, smooth process. It was a period of easy lending. Whether a borrower had bad credit, good credit, or no credit (am I starting to sound like a used-car salesman?), mortgage lenders handed out no-money down mortgages like they were going out of style — even qualifying some borrowers without verifying their income and assets. As we know, these loose lending standards helped cause the housing bubble to burst which led to the financial crisis.

More than a decade later, mortgage lending standards have tightened, with lenders putting a lot of emphasis on creditworthiness. This isn't an issue for borrowers with good credit. But if your credit score isn't up to snuff, you may have to delay your homeownership dreams.

Repairing a low credit score is obvious fix in this situation. This involves paying your bills on time, correcting errors on your credit report, and keeping your debt to a minimum. But what if you're in the process of repairing your credit? It takes time to build a low credit score back up. So while your payment history for the past six to 12 months might be excellent, your credit score could still struggle.

No worries. If your recent credit activity demonstrates a pattern of responsibility, it is possible to get a mortgage with weak credit — even with strict lending requirements.

Learn about FHA home loans

Conventional home loans are a popular choice because they require as little as 5 percent down and include temporary mortgage insurance. Lenders charge private mortgage insurance (PMI) when conventional borrowers put down less than 20 percent (and then cancel premiums once the property has 20 percent equity). The downside of a conventional loan is that lenders typically require a minimum 620 credit score.

A 620 credit score is lower than the loan's previous minimum of 680. Even so, you could find yourself several points shy of the minimum guideline. If that's the case, check out FHA home loans insured by the Federal Housing Administration.

This is an affordable alternative to a conventional loan, particularly if you have a weak credit score. Whereas a conventional loan requires a 620 credit score, an FHA loan allows for much lower credit scores — as low as 500 to 580. This is ideal if you've made a few credit mistakes in the past, yet you're on track to improve your credit score.

Anyone can apply for an FHA loan, but it's certainly a fitting solution if you've filed for bankruptcy or experienced a past foreclosure. Currently, borrowers are eligible for an FHA home loan one year after a Chapter 13 bankruptcy, two years after a Chapter 7 bankruptcy, three years after a foreclosure, and three years after a short sale (one year in cases of extenuating circumstances, such as a job loss or illness). (See also: Is an FHA Home Loan Right for You?)

Prepare for a higher down payment

Be prepared to fork over a larger down payment if you're buying with weak credit. Even though 20 percent down payments are no longer required by lenders, an FHA home loan does require a minimum 3.5 percent down — but only if your credit score is 580 or higher. If you apply for an FHA loan with a credit score between 500 and 579, your mortgage lender will require a minimum 10 percent down.

Choose a portfolio lender

Using a portfolio lender is another option with a low credit score. Because many banks sell their mortgages to investors, they have to ensure these loans meet the requirements set forth by Fannie Mae and Freddie Mac, the government-sponsored entities that buy most of the home mortgages in the U.S. This limits the number of bad credit score loans approved by mortgage lenders.

But if a mortgage lender or bank doesn't sell a percentage of its loans, they have the freedom and flexibility to approve riskier loan applicants — but only if the borrower has compensating factors to offset weak credit like a higher down payment, high income, or substantial assets. These loans are known as portfolio loans because the lender retains the loan as part of its own investment.

Expect a higher interest rate

Even though some mortgage lenders and loan programs accommodate weak credit, there's no escaping a higher mortgage rate. A low credit score and higher rates go hand-in-hand. Because the size of a borrower's down payment and credit affects mortgage rates, people with the lowest credit scores usually pay the highest rates. A higher rate increases borrowing costs and monthly payments, which makes homeownership more expensive in the long run.

Of course, as your credit score improves, so does the opportunity to refinance your mortgage loan. If you refinance down the road and snag a lower rate, you'll reduce the amount you pay in interest and potentially lower your mortgage payment.

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