A Guide to Home Loans for Bad Credit

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Home Loans For Bad Credit

It may not come as a surprise that buying a home can be challenging for people who have bad credit, especially with the new median credit score required to qualify for a new mortgage slowly rising. Lenders like to see high credit scores because it exhibits the borrower’s ability to manage debt, make on-time payments and use their credit responsibly. Even though these things will come into question when a person with poor or bad credit applies for a home loan, they don’t have to let their score hold them back from homeownership.

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This guide will review how bad credit can affect your ability to get approved for a home loan, available home loan options for bad credit and tips for improving your score.

PART I: Home Loan Options For Borrowers with Bad Credit

Conventional Loans for Bad Credit

 Credit Score RequiredDown payment RequiredMortgage InsuranceFees/Fine Print
FHA loans5803.5% (10% for buyers with a credit score less than 580)
RequiredUpfront mortgage insurance
Fannie Mae HomeReady®
program

620
3%Required, but can be canceled once borrower’s home equity reaches 20%
Homeownership education: $75
USDA loansNo minimum credit score0%
Required
Origination: 1-2%; Guarantee fee: 1%; Annual fee: .35%
VA loansNo minimum credit score
0%, unless specified by lender
Not requiredFunding fee varies

FHA loans

Homebuyers turn to government-backed Federal Housing Authority (FHA) loans for many reasons, particularly the low down payment and acceptance of applicants with a low credit score. There is no minimum income requirement, but lenders do want to see that the borrower can afford his or her monthly mortgage payments, if approved.

FHA loan requirements include:

  • A minimum credit score of 580
  • The property must be buyer’s primary residence
  • The property must meet standards outlined by the U.S. Department of Housing and Urban Development (HUD)
  • A down payment of 3.5%; 10% if credit score is lower than 580

If an FHA loan seems like the best option for you, the lender tool on the HUD website can help you find an FHA-approved lender.

VA loans

VA loans carry more relaxed requirements than conventional loans. Backed by the U.S. Department of Veterans Affairs, VA loans are offered to active-duty service members, veterans and their spouses who wish to purchase a condominium, a single-family home, a co-op or a manufactured home. What makes this a great choice for those with bad credit is that there is no minimum credit score or down payment required, unless specified by the lender.

VA loan requirements include:

  • A certificate of Eligibility (COE) to confirm that the buyer is a veteran or an active duty service member
  • The property must be buyer’s primary residence
  • A debt-to-income ratio (DTI) of no more than 41%

Buyers can can contact lenders directly to determine if a VA loan is an available option.

USDA loans

Created by the U.S. Department of Agriculture, USDA loans can be used to purchased property in areas defined as suburban or rural areas across the country. This option is often considered by those who will likely be denied traditional financing because of their low credit score and income. When applying for the USDA loan, applicants are not required to make a down payment, can have closing costs included in the loan and may not be required to have a minimum credit score, unless specified by the lender.

USDA loan requirements include:

  • The property must be the buyer’s primary residence
  • Positive payment history on accounts
  • A very low to moderate income
  • The property must be located in a USDA-eligible area
  • A reliable, verifiable source of income for at least the last 24 months

To find a lender who offers USDA loans, borrowers can review the recent list of approved USDA lenders or contact a specific lender directly to see if it offers this type of loan.

Fannie Mae HomeReady® program

The Fannie Mae HomeReady program is an option for first-time homebuyers as well as repeat buyers. The low down payment of 3%, which can be paid for using grants, a gift, cash-on-hand and Community Seconds® (a subordinate mortgage used in connection with a first mortgage delivered to Fannie Mae), cancellable mortgage insurance and acceptance of low credit scores make this an option to consider.

Fannie Mae HomeReady requirements include:

  • A credit score of 620 or greater
  • A low to moderate income
  • Completion of homeownership education
  • The home must be located in a low-income Census tract area

Buyers can speak to specific lenders to determine if they offer the Fannie Mae HomeReady loan.

Manufactured Home Loans For Bad Credit

Manufactured homes are built in factories then transported to a site where they are permanently affixed to a chassis. Many people who are interested in purchasing this particular type of home turn to financing to cover the cost, whether it is through a bank, credit union or the manufactured-home retailer.

As with purchasing a traditional residential property, those with bad credit have a reduced chance of getting approved for a manufactured-home loan, but there are options that are available to them.

 Credit Score Required
Down payment Required
Mortgage Insurance
Fees/Fine Print
FHA Title I
No minimum credit score
5% (10% if credit score is 500 or lower)
Required
N/A
FHA Title II5803.5% (10% if credit score is 580 or lower)
Required
N/A
Chattel Loans
Varies based on lender
Varies based on lender, but 5% is common
Varies based on lender
N/A
Fannie Mae HomeReady program
6203%Required until buyer’s home equity reaches 20%
Homeownership education: $75
USDA loansNo minimum credit score
Not requiredRequiredOrigination: 1-2%; Guarantee fee: 1%; Annual fee: .35%
VA loans
No minimum credit score
Not required, unless specified by lender
Not required
Funding fee varies

FHA

FHA loans can be used not just to purchase a manufactured home, but also the lot where the manufactured home will be located. When opting for this type of financing, there is a maximum loan amount that varies based on what you are purchasing. For example, if you are only buying a manufactured home, the loan maximum is $69,678, but if you are purchasing the home and the lot, the loan maximum is $92,904. If a buyer does not wish to purchase a lot, he or she can lease, but the lender must have an initial lease term of three years.

FHA loan requirements for the purchase of a manufactured home include:

  • The ability to cover the minimum down payment
  • The home must be used as the primary residence
  • The home’s site must meet local standards
  • Sufficient monthly income to cover cost of the mortgage
  • The home must meet the Model Manufactured Home Installation Standards.

Local manufactured-home retailers can provide borrowers with a list of lenders that offer FHA loans, or they can use the lender tool available on the HUD website.

VA

VA loans are always a great option for veterans and active duty service members who don’t have the best credit or the cash to cover a down payment. If you plan to purchase a manufactured home using a VA loan, you will encounter similar eligibility requirements as those who opt for traditional residential properties, as well as a few additional requirements.

VA loan requirements for the purchase of a manufactured home include:

  • A certificate of Eligibility (COE) from the military
  • Payment of a VA funding fee
  • The home must be affixed to a permanent foundation
  • The home must be considered real estate, rather than personal property

Conventional

Conventional loans can be used to purchase manufactured homes that will be the buyer’s primary residence or second home. The home will be used as collateral for the borrower to secure the loan, and a down payment of at least 5% is often required.

Conventional loan requirements for the purchase of a manufactured home include:

  • The buyer must own the land where the home is located
  • The home cannot have been built on or before June 15, 1976
  • The home should be at least 12 feet wide, with no fewer than 600 square feet of living space
  • The home must be connected to utilities

USDA

USDA loans can be used for the purchase of a manufactured home as well as the lot where the home will be located. Although the home is manufactured, the buyer is still expected to live in a rural area, just as those who choose to purchase a site-built home using this type of loan are.

USDA loan requirements for a manufactured home include:

  • The home must be affixed to a permanent foundation
  • Must purchase a site that is located in a rural area
  • The site must have both adequate water and sewage systems
  • If considered a single-wide, the manufactured unit must be at least 12 feet wide, with no fewer than 400 square feet of living space
  • If considered a double-wide, the manufactured unit must be at least 20 feet wide, with no fewer than 400 square feet of living space

PART II: Ways to Clean Up Bad Credit Before Applying for a Home Loan

With your credit score heavily affecting the total cost of your loan, you’ll want to clean up your bad credit before you apply for any type of home loan. By taking several steps, you won’t just boost it, you’ll save money, too. For example, if you can increase your credit score from the 620-639 range to somewhere between 640 and 659, you can lower your APR by nearly half a percentage point and save around $70 monthly on your mortgage payments.

Tips to improve your credit score

A low credit score can hold you back from getting a home loan, but you don’t have to be stuck with your current score. If you want to improve your credit score before applying for a home loan to increase your chances of approval, there a few different things you can do.

  • Pay down existing debts: Your credit score can drop or rise based on how much debt you currently have and when you make payments. As you pay down your debt, you will increase your score.
  • Pay your bills on time: Payment history is a major part of determining your credit score, so paying your bills on time can mean a score increase.
  • Avoid applying for new credit: Applying for new credit will result in a hard inquiry on your credit report, which can cause your score to drop.
  • Keep old credit accounts open: Keep old accounts open because closing one will shorten the length of your credit history and bring down your score.
  • Address discrepancies on your credit report: It is not unheard of for people to discover inaccurate information on their credit reports, so a thorough review of your report could help you correct any discrepancies that may be bringing down your score.

Getting a mortgage after bankruptcy or foreclosure

Bankruptcy has its benefits, but when a person files, his or her credit score is likely to drop. Even after their bankruptcy has been “discharged,” releasing the debtor of his or her responsibility for the debts, the filer can expect it to remain on his or her credit report for at least seven years, and possibly up to 10.

If you have a bankruptcy filing on your credit report, before applying for a mortgage it might be better to wait until it is removed from your report and work on increasing your score in the meantime, but this not always what people decide to do.

If you choose to apply for a loan before your bankruptcy has been removed from your report, conventional loans and government-backed loans are still an option. You may have to wait a specified amount of time after the bankruptcy has been discharged, which varies based on the type of bankruptcy filed and the type of loan you plan to secure.

For example, someone who has filed a Chapter 7 liquidation will have to wait four years if he or she wants to apply for a conventional home loan. Someone who has filed for Chapter 13 will have to wait one year if he or she wants to apply for an FHA loan. If foreclosure is the cause of the bankruptcy, this can extend the waiting period. However, if the bankruptcy was due to an extenuating circumstance, such as divorce, illness or job loss, buyers may be able to get the waiting period shortened and find a lender that will work with them.

Improve your shot at approval even if you have bad credit

If your credit score is poor and you still wish to apply for a loan, there are things you can do to improve your shot at approval.

  • Put down a bigger down payment: A bigger down payment means you’ll have to borrow less money for the purchase of your home, and with a smaller loan amount, you might get approved.
  • Explain your low credit score: Certain information that appears on your credit report that drags down your score, such as a missed payment that your creditor reported, can be explained or disputed by adding a statement to your report that lenders can see when they pull your credit report.
  • Get your rent payments reported to credit bureaus: Your rent is a monthly bill that can be reported to the credit bureaus and increase your credit score, but this can only help if you have a positive payment history.
  • Decrease the loan amount: Someone with bad credit may have trouble getting approved for a $200,000 loan because it may appear to a lender that he or she can’t afford the monthly mortgage payments due to heavy debt, but if the borrower finds a less expensive home and applies for a loan for $100,000, he or she will be seen as less of a risk to the lender.

PART III: Additional resources

Renting vs. Buying

People often question whether renting or buying is the better option. When making this decision, you’ll want to look at things like your credit score, annual income and monthly expenses to determine which option is the most affordable for you at the current time. Although there are many factors to consider when deciding if you should rent or buy, if you have poor credit, continuing to rent may be the smartest move because it will give you more time to increase your score as well as your chances of getting approved for a home loan.

Watch out for scams that target low-credit homebuyers

When people are desperate to become homeowners, they can easily fall victim to scams, specifically email phishing. For many years, homebuyers have been targeted by fraudsters pretending to be their real estate or settlement agent in order to get the buyer to pay them money that was meant for their closing costs. Buyers receive an email informing them of a change that affects their closing process and how they must pay closing costs. It states that the buyer must wire the funds rather than pay closing costs using a check, but if the money is sent, the fraudster receives the cash, not the correct party.

To avoid this scam, potential homebuyers should not send any personal information or money. They should ensure they have a clear understanding of their lender’s closing process, call their real estate or settlement agent after they receive an email regarding any changes to the closing process, and request the assistance of their bank with confirming ownership of the account where they have been instructed to wire the funds.

Email phishing is not the only scam homebuyers may encounter. Some people opt for a lease-to-own homebuying experience, but this is known to lead to trouble. Often used to take advantage of low-income buyers, a lease-to-own agreement is a way for property owners to profit from the buyer’s inability to cover the cost of repairs for the home. This particular type of agreement leaves buyers unprotected, so instead of being able to get current with payments after they have fallen behind, like a buyer who has a home loan, one missed payment can result in foreclosure. Ultimately, when the home is foreclosed on, the seller is able to collect the rent and any deposits the buyer made while they lived in the home.

To avoid this scam, homebuyers should consider screening the property owner, speaking to an attorney about the agreement and getting a home inspection to reveal any repairs and their extent, which can help them to determine if they can cover the cost of repairs as well as their monthly rent.

FAQs

Yes, but buyers cannot apply for a home loan until the waiting period has lapsed.

Yes, but when refinancing, lenders will review your credit score, so if it has improved since you first applied for your bad credit home loan, you may get a better interest rate and lower monthly payment.

Yes, when applying for a home loan, borrowers can choose to have a cosigner who will be responsible for their debt should they be unable to make their monthly mortgage payments.

No, checking your credit will not cause your score to drop because it is not considered a hard inquiry, which is what can lead to a drop in score.

When one lender has denied your loan application because of a poor credit score, you can apply for a home loan with a different lender, but this can bring down your score because each application will result in a hard inquiry on your credit report. That being said, FICO considers all credit inquiries made within a 45-day period to be only one inquiry, so it may be worth it to shop around and then make a decision based on who you think is most likely to approve your application.

Because credit scores range between 300 and 850, lenders often consider a score of 580 or lower poor or bad.

Homebuyers interested in lowering their interest rate may be offered the opportunity to purchase discount points at closing. This prepaid interest allows people to make a payment — one point is 1% of their loan amount — in exchange for the lender lowering their interest rate by a set percentage amount for every point purchased.

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Kristina Byas
Kristina Byas |

Kristina Byas is a writer at MagnifyMoney. You can email Kristina here

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