Will bad credit keep you from getting a mortgage at today’s historically low rates? While the automatic answer might seem like an instant “yes,” that may not be the case.
Borrowers with bad credit can often get mortgage financing. Equally important, credit scores are not permanent. So, with a few financial adjustments you may be able to improve your score and move into a better credit range, one that will mean lower borrowing costs.
Credit score bands and ranges
Credit scores generally range from 300 at the very bottom to 850 at the top. Some scoring systems for auto loans and bank credit cards can stretch from 250 to 900. As a borrower, you want the highest possible number to get the best rates.
The credit scores of many borrowers, however, are not in the highest ranges. Figures reported last fall from FICO developer Fair Isaac show that the average score last fall reached 706, a record high. At the same time, 28.2 percent of all credit users had scores below 650. The specific population breakdown looks like this.
- 300-499 – 4.3%
- 500-549 – 6.8%
- 550-599 – 7.8%
- 600-649 – 9.3%
- 650-699 – 12.5%
- 700-749 – 16.2%
- 750-799 – 20.7%
- 800-850 – 22.3%
Figures from Experian are similar. It says about 33 percent of all Americans have FICO scores below the “good” range. Experian says the breakdown looks like this, with a scale from 300 to 850.
- Exceptional – 800-850 – 21%
- Very Good – 740-799 – 25%
- Good – 670-739 – 21%
- Fair – 580-669 – 17%
- Very Poor – 300-579 – 16%
Even borrowers in the “fair” and “very poor” bands may be able to qualify for mortgage financing. As an example, in its latest annual report to Congress, the U.S. Department of Housing and Urban Development (HUD) said “the volume of mortgages with credit scores less than 620 has doubled over the last three years.” The share of loans with borrower credit scores below 620 rose from 11.21 percent in fiscal year 2018 to 12.73 percent in 2019, HUD noted.
That’s about 125,000 FHA-insured mortgages in a single year for borrowers in the “fair” and “poor” bands.
How does bad credit affect a home loan application?
Lenders check borrower’s credit scores when deciding whether to approve a loan application and how much interest to charge. With conventional mortgages, the lowest mortgage rates are reserved for borrowers with excellent credit. Credit scores in the mid-600s or lower may make it harder to qualify for a loan. And if you do find a lender willing to lend you money, you might have to pay a much higher interest rate, making it more difficult to repay the loan.
Lenders consider a number of factors when evaluating a mortgage application. They look at such measures as loan-to-value (LTV) and debt-to-income (DTI) ratios. But credit scores are especially important. That’s because borrower’s with lower scores are more financially fragile and more likely to default, something lenders very much want to avoid.
Research from Fair Isaac, developer of the FICO-brand credit scoring system, shows how scores relate to delinquencies.
|Credit Scores & Delinquencies|
|Score Range||Percent of Likely Delinquencies|
|579 and below||61%|
When are credit scores too low to qualify for a mortgage
The concern about defaults tied to low credit scores can be seen from the chart above. Does a lender want to make a loan where the odds of delinquency are 1 percent or 61 percent? The answer depends on the lender’s risk appetite and how much risk they can potentially offset by charging higher rates. Some will make loans to borrowers with low credit scores while others will simply pass.
How much extra will low credit scores cost you?
For more than a year, mortgage rates to finance and refinance have generally moved lower. The average 30-year fixed mortgage rate was 4.87 percent in November 2019 according to Freddie Mac. By March 2020 the average rate fell to 3.56 percent. That’s a huge decline of more than a full percentage point in a three-month span. (And rates are expected to slide further due to fears of an economic slowdown caused by the coronavirus.)
Lower mortgage rates mean smaller monthly payments for principal and interest, and lower costs over the life of the loan. That said, there’s still a significant difference between the rates available to those with high scores and the interest levels for borrowers with bad credit.
How much of a difference?
The table below shows that home loans for bad credit borrowers are significantly more expensive than mortgages for borrowers with good credit. Examples are based on national averages for a 30-year fixed loan of $220,000, using myFICO.com’s loan savings calculator. Here’s how much you’d pay at rates available at the time of publication, depending on your credit score range.
|MyFICO Loan Savings Calculator|
|FICO Score||APR||Monthly Payment||Total Interest Paid|
Should you get a mortgage or increase your credit score first?
If you look at the loan savings chart you can see two things. First, bad credit means higher mortgage loan costs. Second, the chart does not go below 620. You can guess that credit scores below 620 lead to even-higher financing costs.
These two realities raise a question. Should you take out a mortgage now or increase your credit score before you apply for financing? The best answer is to plan ahead.
Credit scores continually fluctuate, so it’s worth taking steps to improve your credit score before researching a home purchase. Even if you only raise your credit score to 665 or so from 650, you might be able to cut your mortgage costs significantly. As an example, over the course of a 30-year mortgage your monthly payment will be lower and you can save roughly $20,000 for the $220,000 loan illustrated above.
Increasing your chances of mortgage approval
If you want to get a mortgage, a car loan, or just about any other form of financing, the time to improve your credit standing is now. You can become your own credit repair specialist by taking several steps. Why now? Because it can take weeks if not longer to resolve credit report issues and you want to get them straightened out before applying for a mortgage. Give yourself at least 90 days to deal with credit reports.
- Check your credit report for free at AnnualCreditReport.com. Your credit score is based on the information contained in your credit report. According to a 2013 Federal Trade Commission study, one in five consumers had an error on at least one of their three credit reports. In some cases the errors were bad enough to lower credit scores by 25 points or more. If you see a mistake or old item – generally seven years but sometimes longer for bankruptcies, liens and judgments – contact Equifax, Experian, or TransUnion. Each of the credit bureaus has a process for correcting errors and out-of-date items.
- Create a budget. To improve your credit standing you must know what you are spending to avoid racking up debt. The only way to do this is with a budget that tracks income and expenses. Look for small savings – they add up.
- Make all payments on time and in full. This is the gold standard for good credit. Develop the habit of making bill payments on time. This will allow you to avoid late fees and other needless costs, as well as blemishes on your credit report.
- Save. You must have money available for emergencies. Set aside cash every week or pay period. As a start, make sure you have at least $400 in savings. You must also have cash to buy real estate, not only for a down payment but also for closing costs.
- Use the UltraFICO and Experian Boost programs. These programs track the movement of cash in your bank account and in many cases your score may go up. “For consumers with a score below 680, 75 percent saw an improvement in their credit score,” says Experian. Adds Fair Isaac, “seven out of 10 consumers in the U.S. who exhibit sound financial behavior in their checking and savings accounts see an UltraFICO Score that is higher than their traditional FICO Score.”
- Be careful about closing credit cards. A closed credit card can lower your credit score. The reason? Closing a card causes your available credit to drop, reducing your borrowing power and, more importantly, your credit-utilization ratio (a measure of how much credit you have used relative to your total credit availability.)
- Time counts. The sooner you take control of your finances the more likely that your credit scores will rise.
How to get a mortgage with bad credit
Bad credit can cost you big bucks when you finance or refinance real estate. There’s no shortage of bad credit financing, but if you want to pay less there are a number of steps you can take to improve your situation.
- Shop around. Some lenders offer better financing terms than others. You may be able to save thousands of dollars by merely checking with various lenders and locking in a lower rate or pay less in fees.
- Check for all types of bad credit home loans available in your area. In particular, look for programs widely used by first-time and entry-level buyers such as FHA mortgages (as little as 3.5 percent down), VA financing (zero down), USDA mortgages (zero down), Fannie Mae HomeReady mortgages (3 percent down), and the Freddie Mac Home Possible plan (3 percent down).
- Find a co-signer. If you have bad credit, you might consider seeking help from a friend or family member. This is no small favor, as the co-signer is responsible for repayment of the entire debt, not just a part, if you default. Also, if payments are late or not made, the co-signer’s credit will be damaged.
- See if you qualify for down payment assistance. There are more than 2,500 programs nationwide to offset down payment costs via grants and credits. You can search by location at DownPaymentResource.com.
- Look for first-time buyer programs. You may qualify for “first-time” homebuyer programs even if you have owned property before. In many cases a “first-time” buyer is defined as someone who has not held title to real estate during the past three years. Ask lenders for details.
- Look at a variety of lenders. Today we have traditional banks, nonbanks, online banks, credit unions, community banks, mortgage bankers and mortgage brokers. They all want your business. Let them compete for it.
- Make a larger down payment. It is possible to have both bad credit and substantial savings. Lenders are often willing to accept a borrower with bad credit in exchange for a large down payment.
- Don’t open a new credit card account or make a big purchase. A new credit account or big purchase can push down credit scores. Avoid taking on, or applying for, new debt when applying for a mortgage until your home loan has been funded.
Bad credit mortgage loans guaranteed approval
If you see come-ons promising “guarantee approval,” red flags should go up. If approval is guaranteed then what about fees, interest rates and prepayment penalties? What standards can a lender possibly have?
Under federal rules a lender must verify the ability of a residential borrower to repay the debt.
“Lenders,” according to the Consumer Financial Protection Bureau, “must generally find out, consider, and document a borrower’s income, assets, employment, credit history, and monthly expenses. Lenders cannot just use an introductory or “teaser” rate to figure out if a borrower can repay a loan. For example, if a mortgage has a low interest rate that goes up in later years, the lender has to make a reasonable effort to figure out if the borrower can pay the higher interest rate too.”
Consider a rapid rescore
Credit report changes may take time to go through the system. That means improved scores may not show up in time for a mortgage application. You may want to get a so-called rapid rescore through your lender in this situation.
“The term “rapid rescore,” says Experian, “refers to a process by which a mortgage lender submits proof to a credit reporting agency of recent changes or updates to account information that are not yet reflected on the credit report. Because mortgage loans are often time-sensitive, the lender pays a fee to the credit reporting agency to have the new information updated within an expedited time frame.
“Once the credit report is updated,” Experian continues, “a new credit score can be requested that will reflect those updates and ideally result in a higher score. This service is offered only through your lender, so you cannot request a rapid rescore on your own.”
Remember, even a few points may move you into a new credit scoring range. That higher and range can mean lower mortgage payments for years to come.
Home loans for bad credit
The bottom-line: Bad credit doesn’t have to get in the way of securing an affordable mortgage. Once you’ve made it a goal to become a homeowner, you may find yourself more motivated to clean up your credit report, improve your payment history, and comparison-shop for mortgages.
A good credit score is above 700. Very good scores are above 740 and exceptional scores are above 800.
Raising your scores after a blemish on your credit report or building credit for the first time will take patience and discipline. You can expect it to take a few months to two years to build a good credit score, but you can speed the improvement by following Bankrate strategies.