How To Apply For Home Loans With Bad Credit
Posted on February 8, 2021 in Loans
The harsh reality is that anyone with bad credit will have a hard time getting approved for a loan. Even if the loan is accepted, the terms of the loan will almost certainly not be favorable and typically will have a higher interest rate if not also requiring a larger down payment or even a co-signer to get approved.
Before ever looking into a loan, the first step should be to try and have the highest credit score possible. Even with a low credit score, not all hope is lost when getting a home loan. There are still plenty of good options for loans out there, even in the event of having bad credit.
What Exactly Is Bad Credit?
First, it is important to understand exactly what bad credit even means. Credit scores are composed of a three-digit number designed to represent the likelihood that someone will pay back their bills on time. The number will range from 300 to 850, and the higher the number, the better the credit terms offered. Here is a general look at the credit score ranges and what they represent:
- 300-579: Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very Good
- 800-850: Excellent
A combination of five different factors determines this number. By focusing on improving these, the number will improve and go a long way toward helping the terms of a home loan:
- Payment History (35%)
- Credit Utilization (30%)
- Credit History (15%)
- Types of Credit (10%)
- New Credit (10%)
There is no such thing as a minimum score required by a lender to approve a home loan. However, in general, anyone with a credit score of less than 500 should probably focus on getting their score a little higher before applying for any home loans.
Ideally, a credit score should be above 670 before looking into getting a home loan. Anything underneath that score is considered “subprime,” and as a result, the lenders of the loan will want more compensation for taking out a higher risk by offering the loan.
Higher interest rates and larger down payments are typical when offering a loan to an individual with a subprime credit score.
Other Factors For Getting A Home Loan
Alongside a credit score, a lender will look into several other factors when reviewing a home loan application. Anyone with a bad credit score can do a lot to help themselves out by improving these factors if their score isn’t ideal:
- Down Payment Amount
The best thing that someone with a low credit score can do to help a lender approve their loan is to use cash and put up a large deposit via a down payment. The higher the down payment offered, the more likely the loan will be approved.
- Low Amount of Debt
Having a lot of debt will negatively impact a credit score, but sometimes, even if the debt is repaid, the damage done will take a while to come off the credit report. Paying off other debts may not help the credit score immediately, but it will help ease the lenders’ minds reviewing the loan application.
- Yearly Income
Home loans are generally offered with decades to repay, so yearly income is absolutely a key factor in determining the likelihood of the loan being repaid.
In other words, the more money a person makes in a year the more they can afford to repay and the faster the loan will be paid.
- Debts In Collection
If a person takes out a loan and defaults by not paying back in time, the loan can be sent to a collection agency. These people will try to get the loan repaid, and if not, it can get a little messy from a legal standpoint.
As far as credit reports go, when a debt goes to collection, it can be a big red flag for any future lenders, so it is important to handle these debts and have the collection removed if possible.
Different Options Available For Home Loans
When it comes to taking out loans for a home, there are several more options available than other types of loans. Specifically, there are loans backed and insured by the federal government, which are not generally found in other types of loans. This can be a huge benefit when it comes to getting a loan with bad credit.
Here is a list of the few different types of loans available:
- Conventional Loans
These are the traditional loans that most people imagine when they hear the term “home loan” and are generally offered by banks and credit unions. Unlike some of the other options on this list, these loans are mortgages that are not insured or guaranteed by the federal government. As a result, they may be harder to qualify for and will typically require a larger down payment, higher credit score, lower-income to debt ratio, and maybe even private mortgage insurance. Although harder to qualify for, they are generally less expensive than the loans guaranteed by the federal government.
- FHA Loans
The Federal Housing Administration, or FHA, is a part of the United States Department of Housing and Urban Development, and they provide various types of mortgage loan programs.
These loans are much easier to qualify for and have lower down payments than conventional loans. For anyone with bad credit or any first-time home buyers, this is probably the best option available due to the lower upfront costs of the loan and less strict credit requirements.
The traditional down payment for a home is usually 20% of the value, but with FHA loans, they can be as low as 3.5% savings tens of thousands of dollars. An FHA loan’s downside is the mortgage insurance premium, which is rolled into the monthly mortgage payment. This is an insurance policy that protects a mortgage lender if the borrower defaults on payments. These premiums are between 0.5% and 5% of the original loan, so they can easily reach over a hundred dollars a month on top of the mortgage terms.
- VA Loans
The United States Departments of Veterans Affairs, or VA, does not make loans, but it does guarantee mortgages made by qualified lenders. These guarantees will help veterans to obtain favorable terms in a home loan and usually without requiring a down payment.
Most of the time, VA loans will be easier to qualify for than a conventional loan once the VA accepts eligibility. If accepted, a certificate of eligibility is issued and can be used to help apply for the loan.
- USDA Loans
The United States Department of Agriculture, or USDA, is another option for anyone looking for a home in a rural area. Interest rates on these loans can fall as low as 1%, and generally, a credit score of 640 or higher will be enough to secure one.
The monthly payment on a USDA loan is generally restricted to 29% or less of the borrower’s monthly income, and other monthly payments can’t exceed 41% of their monthly income.
Additional qualifications include an adjusted household income that must be at or below the applicable low-income limit set by the government for the area the home is located. Additionally, the home must be in a government-designated rural area.
Anyone with bad credit should try to improve their credit before taking out a home loan, but that is not necessarily a requirement. There are still plenty of loan options available to anyone with bad credit based on several different qualifications.
Qualifying for a loan to purchase a home can be a stressful process. Although the terms of these loans can be reworked down the line, they will be a part of a home buyer’s finances for decades. Because of this, it’s imperative to try to get the best terms available on the original loan terms. A borrower with bad credit can get a home loan that is still very reasonable, but if they can wait and improve their credit score first, then they probably should.
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