Are you a first-time homebuyer with less than perfect credit? You probably think you can’t get a home loan because of it. We have good news, though. There are plenty of ways to get a mortgage even if your credit is less than perfect.
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FHA Loans for Borrowers With Bad Credit
You may have heard of FHA loans being called the ‘first-time homebuyer’s loan.’ While that was the case, it really is a loan for anyone today; however, it is a great option for first-time homebuyers with low credit scores and little money to put down a home.
FHA loans require a 580 credit score, but will even go as low as a 500 credit score if you put down at least 10%. This may exclude certain borrowers with low credit scores, because those borrowers generally don’t have any money saved. But, even allowing borrowers with a 580 credit score is a benefit that many other loan programs don’t allow.
Along with the 580 credit score, FHA loans require:
- Minimum 3.5% down payment
- Stable employment and income for the last 2 years
- Maximum housing ratio of 31%
- Maximum total debt ratio of 43%
As you can see, FHA loans have flexible guidelines compared to conventional loans that require higher credit scores and lower debt ratios. FHA loans also allow you to receive 100% of your down payment as a gift as long as you have a credit score above 580.
VA Loans for Veterans With Bad Credit
Veterans that served at least 90 days during wartime or 181 days during peacetime and have an honorable discharge have the benefit of the VA loan. Just like the FHA loan, the VA loan has flexible credit score guidelines. In fact, the VA doesn’t require a minimum credit score; they leave it up to the lender’s discretion. On average, though, many lenders require at least a 620 credit score, but it’s possible to find lenders that think outside of the box and allow lower scores.
The other factors that the VA requires include:
- No down payment
- Stable employment and income for the last 2 years
- Maximum total debt ratio of 43%
- Disposable income in an amount that meets the VA’s guidelines for your location and family size
If you are a veteran, it’s worth exploring this option, as it doesn’t require a down payment. You also only have to pay a 2.15% funding fee and don’t have to pay mortgage insurance, as you would for the FHA loan.
Subprime or Alternative Documentation Loans
If you don’t qualify for a government-backed loan, there is also the option of the alternative documentation loans. You may know them as subprime loans; they are the same thing. Basically, they are loans that lenders keep on their books. This allows the lenders to make their own rules. They don’t have secondary investors to answer to, so the lenders can decide what risks they want to take with the loan.
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You may have to shop around to find a lender willing to take your situation, though. Each lender has a niche market that they cater to, so you’ll have to find the lender that meets your needs.
Watch Your Compensating Factors
If there’s one thing you can do to increase your chances of getting approved for a loan with bad credit, it’s to increase your compensating factors. These include:
- A large down payment – This might be a hard one to accomplish, but if you have money saved, it can help your chances of approval. The more of your own money that you have invested in the home, the less risk the lender takes. You don’t have to put down 20%, but if you can muster up more than the standard 3.5% FHA down payment, you could be in good shape.
- A low debt ratio – Lenders will be more willing to give you a loan if you aren’t already bogged down with debt. If you apply for a mortgage with a low debt ratio, it gives you more room for a mortgage payment without going over the lender’s guidelines.
- Increasing income – If you can show a lender that your income steadily increases year over year, you could be in good shape to secure a mortgage even with a low credit score. Increasing income shows lenders reliability and stability, which are two of the things they look for in a borrower.
As a first-time homebuyer, you have your work cut out for you, especially if you have bad credit. Lenders don’t have a mortgage payment history to base your approval off of, so they have to rely on your credit and other factors. If your credit score is low, you will need other compensating factors to show lenders that you are a good risk despite the low scores.
