In the mortgage industry, there used to be the ability to look for work around for bad credit history. Most potential borrowers were able to purchase a home with some type of financing. Granted, it typically meant a higher interest rate and more fees, but there was always a mortgage product available.
Fast forward to today and there are fewer mortgage products available for those with bad credit, especially first-time homebuyers because of the lack of desire to take risks that lenders possess as well as the new Qualified Mortgage Rules that are in place. Does that mean you are out of luck completely? The good news is no, you have plenty of options to help you become a homeowner. Here are a few ways to get you started.
Apply for Government-Backed Financing
Conventional loans might be out of the realm of possibilities for you when it comes to home ownership if you have bad credit and no housing history, but government-backed programs could be a viable option.
VA, FHA, and USDA loans all provide loans for many people with their requirements that are not nearly as strict as conventional guidelines. They have lower credit score requirements, have exceptions for negative credit history, and are more lenient when it comes to debt ratios and LTVs.
If you are a veteran, you could start with VA financing as it is a very lucrative form of financing for those that served our country that requires no down payment. If you are not a veteran, but plan to move into a rural area, consider USDA financing, which is another program that offers 100% financing. The largest requirement with this program is the need for your income to fit into the average income for the area – you cannot make more than the average income or you do not qualify.
Last, but not least, is FHA financing, which does not require you to be a veteran or move into a rural area and has very liberal qualifying guidelines with only a 3.5% down payment required.
Come up with Compensating Factors
If you have your heart set on qualifying for conventional financing, you will need to come up with some compensating factors to make up for your bad credit. Most lenders will take into consideration qualifying factors that make a loan less risky. These qualifying factors include:
- A large down payment – The absolute minimum down payment for a conventional loan is 3% to qualify for the Fannie 97 loan, but the higher the down payment you make, the more likely you are to get approved. The magic number is 20%, but if you have bad credit, chances are you do not have that kind of money lying around. Put down as much of a down payment as you can to increase your chances of getting approved, though.
- Have reserves on hand – If you do not want to put all of your money down on the home up front, you need to have a sizeable savings account to show the lender, which can serve as reserves. This is money you have set aside for an emergency. The lender will look at it as money that you can use to make your mortgage payments should your income become compromised. The larger number of months you can cover with reserves, the lower risk you create for the lender.
- Lower your debt – If your debt ratio is high and your credit is bad, you are a recipe for a high-risk borrower. The best way to lower that risk is to get rid of some debt. The sooner you start on this, the quicker you will get the debt paid down. Your debt ratio is comprised of every monthly payment that reports on your credit report. If you can pay debts off completely, you can really lower your debt ratio. If you are unable to pay them off entirely, at the very least, pay them down as much as possible in order to get your debt ratios lower than the maximums allowed for the program you want.
Take the Higher Interest Rate
If you cannot come up with any compensating factors or you cannot qualify for a loan with a low interest rate, do not discount the idea of taking the higher interest rate. There is a benefit to doing so – you get to become a homeowner! If you can afford the higher payments without struggle, go ahead and take the loan and then work on making your credit better over the next few years.
Once you have debts paid down, timely payments that bring your score back up, and stable income, you can refinance into a lower rate. You are not stuck in the high interest rate forever, especially since the Qualified Mortgage Rules do not allow for most programs to give you a prepayment penalty, you are free to pay off your current mortgage at any time, enabling you to refinance when it is more feasible in the future.
Put off a Home Purchase for Now
If you really have bad credit and do not have a solid housing history to back it up, you might need to rent for a few more years. Renting from a qualified landlord can provide you with the solid housing history that you require to get approved for a loan.
It might not be the ideal situation for you if you want to become a homeowner, but a rent history with no late payments for several years can really help you get approved for a loan.
As an added benefit, you can save more money for the down payment or reserves and improve your credit during the time that you wait to become a homeowner.
Having bad credit does not mean you cannot become a first-time homebuyer; you just might have to get more creative with your financing options. If you work hard and shop with many different lenders, you will likely find that you have many options at your disposal. The best scenario is to get your finances in line before applying, but if that is not possible, make sure to explore all of your possibilities.