Follow These 10 Steps to (Still!) Get a Mortgage … Even With Bad Credit

Step 1: Start saving money now

The compensating factors Helali refers to means that a lender is more likely to provide a loan to buyers with lower credit scores if they can put down a larger down payment, have a high income, or have a lot of money in reserve.

For example, if you want an FHA loan, you may be able to put down as little as 3.5% if your credit score is at least 580. However, if your credit score is between 500 and 579, you need a down payment equal to at least 10% of the purchase price to qualify for an FHA loan.

If you’re buying a $200,000 house, a 3.5% down payment is $7,000, while a 10% down payment is $20,000.

Step 2: Look into state and local assistance programs

Saving enough for a down payment can be a challenge for first-time buyers, and that’s why a variety of down payment assistance programs exist. Some programs provide a grant, which doesn’t need to be paid back. Other programs offer loans, but they may have features that make it easier for you to pay the loan back, such as 0% interest.

You may find down payment assistance programs sponsored by state and local housing authorities, nonprofit organizations, and other groups. Check this HUD list for programs in your state. Your lender may also be able to recommend programs.

Step 3: Request a copy of your credit report

Your credit score is based on the information that’s contained in your credit report, so review your credit report and correct errors before applying for a mortgage.

You’re entitled to a free copy of your credit report annually from each of the three major credit bureaus: Experian, Equifax, and TransUnion. The easiest way to request your file is through annualcreditreport.com, a site the bureaus set up to provide free reports.

If you plan to apply for a mortgage soon, review all three reports now. Otherwise, you might want to space your requests out over the year to better monitor changes to your record.

Step 4: Dispute any inaccuracies

When you review your credit report, you may find errors. For instance, the report may show a debt as being still owed when you’ve already paid it off.

The credit report includes instructions on how to dispute any mistakes you find. You may have to contact the creditor and provide documentation, such as a copy of a canceled check, to get the issue resolved.

Clearing up inaccuracies on your credit report can raise your credit score, so take care of any problems you find before you apply for a mortgage. For example, Helali worked with buyers whose credit was dinged because they forgot to pay a $3 charge on a store credit card. The buyers called the card issuer, got the card company to forgive the debt, and asked the issuer to update their status to the credit bureau immediately. Those steps allowed them to qualify for a much better interest rate.

“The credit card company doesn’t have to forgive you or let the credit bureau know — but it never hurts to ask,” Helali notes.

Step 5: Assess what kind of a loan you can get

Different loan programs are designed for borrowers with varying credit histories, and requirements differ.

VA (Veterans Administration) loan

VA loans, which are backed by the federal government, are open to qualified veterans, activity-duty military personnel, and surviving spouses. There may be zero down payment required, and this loan doesn’t require mortgage insurance.

The VA doesn’t set a minimum credit score, but lenders can impose one. Generally, lenders require a credit score of at least 620, although some lenders may accept scores as low as 580.

FHA loans

The Federal Housing Administration insures FHA mortgages, making them less of a risk for lenders. Buyers with a credit score above 580 can put down 3.5%, while buyers with a credit score between 500 and 579 must put down 10%.

USDA loans

The U.S. Department of Agriculture guarantees loans for low- and moderate-income buyers in rural areas. The agency doesn’t set a minimum credit score, but many lenders require a score of 640. USDA loans may be available with no money down.

Fannie Mae HomeReady loan

This program is for buyers who earn less than 80% of the median income for the home’s area. Buyers must have a credit score of at least 620. The minimum down payment is 3%.

Freddie Mac Home Possible loan

This program has the same income cap as the Fannie Mae program (80% of the median income in the area) and requires at least 3% down. The minimum credit score is 660.

Small lenders and credit unions

Small lenders and credit unions that keep mortgages in their portfolios, rather than selling the loans as most lenders do, have more leeway in who they lend to. They may be more willing to lend to buyers with a low credit score, although they may also look for mitigating factors such as high income or a large down payment.

Step 6. Can you increase your income?

Along with your credit score, the lender will look at your debt-to-income ratio or DTI. To figure out your DTI, add up all your monthly minimum debt payments (like car loans and credit cards) plus the amount you expect to pay for a mortgage, and divide it by your gross monthly income. Lenders generally prefer your DTI to be under 43%.

If you can increase your income, you’ll lower your DTI. Can you get overtime hours on your job or take on a part-time second job?

Lenders may also see a higher income figure as a compensating factor that counteracts your low credit score.

Step 7. Can you decrease your debts?

Making your debts smaller has the same effect on your DTI as increasing your income, and it also typically improves your credit score.

If you don’t have a lot of money saved up that you could use to pay debts, do you have anything you could sell to raise money? Whether it’s a couple of hundred dollars from a yard sale or a couple thousand from selling personal watercraft, using that money to retire debts or pay off a credit card could help you qualify for a mortgage.

Be realistic about how much house you can afford, too, Helali advises. Buying a less expensive house means lower mortgage payments, which may enable you to qualify for a mortgage.

Step 8. Can you find a cosigner?

A cosigner is another person who signs the promissory note and helps you get a mortgage because the lender includes their income and credit score with yours to qualify you for the loan. The cosigner is responsible for the debt if you default, so not everyone is willing to take on the responsibility.

Generally, a cosigner, or co-applicant, is understood to be occupying the home along with the primary borrower, although a non-occupant co-applicant may be accepted. Conventional loans have some restrictions on non-occupant applicants, Helali says, but “with FHA loans, they usually just want to know if it’s a non-occupant.”

Step 9. Get your documents together

When you apply for a mortgage, you have to submit a lot of documents, so gather them before you apply. A delay in paperwork can slow the approval process.

If your credit report indicates problems with how you handle credit, such as missed payments, the lender may ask you to write a letter explaining the issue. Keep the letter brief; state a reason for the unpaid bills, such as illness or temporary job loss, and whether you’ve rectified the situation.

Step 10. Talk to a loan originator

Reach out to a reputable lender and ask if you could qualify for a mortgage. They’ll look at your credit score, DTI, income, and savings and then let you know if they might have any programs you could qualify for.

“This is where a good loan officer shines,” Helali says, because the officer can look for mitigating factors, assistance programs, and other ways to help you qualify.

If the lender doesn’t have any programs that are right for you, they may recommend you use a mortgage broker. A mortgage broker works directly with several lenders and may have connections with a lender that accepts clients with low credit scores.

“If you start with a standard lender and they say no, go to a broker,” Helali says.

Find an Agent to Help You Buy Your First Home

A top agent who knows your housing market can help you identify and navigate local and national down payment assistance and loan programs. HomeLight can connect you with an experienced buyer’s agent who will walk you through the process of buying your first home.

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Didn’t get a loan? You can always improve your credit

It’s possible you won’t find a lender who’ll accept your mortgage application, especially if your credit score is under 600. However, it’s worth a try, Helali says.

“If you go to a lender and ask if you can get approved, the worst that can happen is they say no.” But if you don’t ask, you definitely won’t get approved. Note, though, that your credit score can take a small, temporary hit after applying with a lender since they’ll typically pull your credit.

Don’t get discouraged if you’re turned down for a mortgage. Instead, use your disappointment to boost your efforts to improve your credit score.

It may take about six months to see real improvement in your score, which is why you should work on your score while you’re searching for a mortgage option.

You can take several steps to improve your credit score. Here are some of the basics.

Be sure to pay all your bills on time, every month.

Your payment history, including late and missed payments, is one of the most important factors in your credit score. A history of paying bills on time can help raise your score.

Set up automatic payments for bills if you have a hard time keeping track of what’s due when.

Pay down your debts.

In addition to hurting your DTI, the amounts you owe affect your credit score. Credit utilization compares how much credit you’re using to the total amount of credit available on all your accounts.

Using more than 30% of your available credit can ding your credit score, so reduce the balances on your lines of credit. Lower balances also mean you’ll be paying less interest on your credit cards, so you’ll save money, too!

Keep lines of credit open, even if you’ve paid them off.

This advice may seem counterintuitive, but the length of your credit history impacts your credit score. Keeping old accounts open, even if you don’t use them, gives you longer credit history and helps your score. The credit limits on unused accounts also help lower your credit utilization percentage.

Consider whether you have the right credit mix.

Your credit mix, or the different kinds of credit accounts you have, can impact your credit score. A good mix includes both installment credit (loans you make monthly payments on, like a car loan) and revolving credit (credit cards).

Before rushing out to open new accounts, ask a personal finance expert whether changing the mix would help your score. Opening new accounts can also negatively impact your score, so trying to change the mix may not help your situation.

After you’ve established a history of on-time payments and reduced your debts, you can restart your search for a mortgage. And this time, you may not have to worry about having too low of a credit score!

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