When you apply for a home loan, most lenders will largely base their approval or denial decision on the same four factors. These are your income level, your debt level, your financial assets and your credit rating. They have specific debt-to-income ratios that you must meet. They also want to see that you have enough money to pay the down payment and closing costs while still having a reasonable reserve of funds remaining in your accounts after closing. Most home lenders also require that borrowers have good to excellent credit scores. However, if you think that you have less than perfect credit and are ready to become a homeowner, you may be wondering what your options are for getting a home loan. The good news is that you may still be able to qualify for a home loan with lower credit scores in some cases.
Review Your Current Credit Rating
If you have not reviewed your credit rating recently, it is important that you do so as a first step. Ensure that all information being reported about you is correct. Examine your scores from all three credit reporting bureaus. Some people are surprised to learn that their scores are higher than thought, and others have the opposite experience. Your lender will need to know your credit scores to pre-qualify you, and you can save yourself loan application fees and unnecessarily credit pulls by telling a loan rep your credit scores up-front.
Take Time to Repair Your Credit Rating
Because of the importance of having a good credit rating to qualify for a loan and to get the best interest rates available, you may take time to repair your credit rating before applying for a mortgage. Some people, for example, may have a low credit score because they have too many outstanding accounts. Spending a few months paying off and even closing some of your accounts may have a positive impact on your credit rating. If you have an outstanding collection account with a balance owed, this can be impacting your credit score. Most lenders will require you to pay the collection account off before closing anyway, so it may be best to pay it off now and wait a few months for your credit scores to increase as a result. It may be wise to work with a credit repair specialist as well. Credit scores are calculated based on complicated algorithms, and some people make financial decisions with the belief that they will improve their credit scores. However, they may have the opposite effect of decreasing their scores. A credit repair expert can help you to make the most effective changes to your credit report.
Consider an FHA Home Loan
Most banks and lenders offer FHA home loans. These are special loans backed by the Federal Housing Association, and they typically are characterized by having a competitive interest rates and low down payment and closing cost requirements. If you put down less than 20 percent, however, you may have to pay PMI. PMI can increase your monthly payments for year to come in some cases. FHA loans have specific requirements, especially involving your ability to make your housing payments on time. However, they are often more lenient on credit scores than other loan programs.
Have Compensating Loan Factors
Whether you consider an FHA loan or another type of home loan, some lenders may be more willing to accept a lower credit score if you have other positive, compensating factors. For example, your scores may be lower because of an event that happened a few years ago. However, you may have worked hard over the last few years to improve your financial situation, and you may now have minimal debts in your name. You may also have substantial liquid assets in your bank accounts. These are some of the compensating factors that may make a lender more inclined to approve your loan on an exception basis. While some lenders are willing to do this, others stick firmly to the minimum credit score requirements their institution has established.
Your mortgage payment will be a major expense in your budget for many long years. The interest rate that you qualify for is based on your credit rating and will directly impact your mortgage payment. Even if you can qualify for a higher rate under some loan programs with a bad credit score, it may make sense to stay in your current home for a few more months or years until your credit rating and financial status have improved. Taking on the expenses of home maintenance, mortgage payments and more can be difficult to manage when your finances are not solid, so you should only purchase a home when you are comfortable with your financial situation.