What Do Lenders Consider Bad Credit?

Lenders have their own criteria for what they consider a “bad” credit score. Typically, any credit score below 620 is considered poor or subprime. However, many lenders are still willing to work with borrowers with lower scores if they meet other criteria or have compensating factors.

“While many borrowers think they’re stuck with bad credit, it’s possible to secure a mortgage if you can demonstrate job stability and save for a larger down payment,” says David Clarkson, Senior Loan Advisor at EquityFirst Lending Group.

Credit Score Ranges for Mortgages:

• Excellent Credit: 720+
• Good Credit: 680-719
• Fair Credit: 620-679
• Below Average Credit: 580-619
• Bad Credit: 579 and lower

It’s important to remember that your credit score isn’t the only factor lenders consider. They also look at your credit history, income, and overall debt to determine your ability to repay the loan.

Mortgage Programs for Borrowers with Bad Credit

There are several loan programs available for borrowers with credit scores as low as 580. Below is a breakdown of the most common mortgage options:

Loan Program Credit Score Requirements

FHA Loans

• Credit Score Requirement: 580+ for 3.5% down; 500-579 requires 10% down.
• Description: FHA loans are insured by the Federal Housing Administration, making them a popular choice for first-time homebuyers and those with low credit scores. They offer flexible credit and income guidelines, making it easier to qualify.

VA Loans

• Credit Score Requirement: 580+ (varies by lender).
• Description: VA loans are available to veterans, active-duty military, and eligible spouses. These loans have no down payment requirements, no private mortgage insurance (PMI), and competitive interest rates.

Conventional Loans

• Credit Score Requirement: 620+.
• Description: Conventional loans are not backed by the government and are typically offered by private lenders. They require a higher credit score than government-backed loans but offer flexible options, especially for those with a 20% down payment to avoid PMI.

USDA Loans

• Credit Score Requirement: 640+.
• Description: USDA loans are designed for low-to-moderate-income borrowers purchasing in rural areas. They offer 100% financing with no down payment required, but you must meet income limits based on the area’s median income.

Down Payment Assistance Programs

Many states have down payment assistance programs to help low-income borrowers, including those with bad credit. These programs provide grants or low-interest loans to cover the down payment and closing costs, making it easier to afford a home. Some programs even allow 100% of the down payment to be a gift from family or friends.

• National Homebuyers Fund (NHF)
  • Offers grants up to 5% of the loan amount for down payment and closing costs. Available for FHA, VA, USDA, and conventional loans. No first-time homebuyer requirement.
  • Learn more and apply here.
• Good Neighbor Next Door Program
  • Designed for law enforcement officers, firefighters, teachers, and EMTs. Offers 50% off the home price in revitalization areas. Down payment assistance can cover upfront costs.
  • Learn more and apply here.
• State-Specific Down Payment Assistance Programs
  • Many states offer their own down payment assistance programs. For example, the Texas State Affordable Housing Corporation (TSAHC) offers up to 5% of the loan amount for down payments and closing costs.
  • Find your state’s program and apply.
• HomeReady and Home Possible Loans
  • Offered by Fannie Mae and Freddie Mac, these programs require as little as 3% down payment and allow for down payment assistance from external programs.
  • HomeReady Program Info
  • Home Possible Program Info.
• Community Seconds® and Affordable Seconds® Programs
  • Offered through Fannie Mae and Freddie Mac, these allow borrowers to get a second loan to cover their down payment, often with deferred or zero-interest payments.
  • Community Seconds® Info
  • Affordable Seconds® Info.

These programs can make it easier for eligible buyers to achieve homeownership. Be sure to check your state’s local options and specific program requirements.

Tips for Improving Your Credit Before Applying

Improving your credit score can help you secure better interest rates and loan terms. Here are some actionable tips:

• Pay Down Debt: Lowering your overall debt decreases your debt-to-income ratio, which makes you less risky to lenders.
• Dispute Errors on Your Credit Report: Dispute any inaccuracies on your credit report to potentially raise your score.
• Avoid Applying for New Credit: New inquiries can lower your score temporarily and add to your total debt.
• Make On-Time Payments: Your payment history accounts for 35% of your credit score, so never miss a payment.
• Increase Your Credit Limits: If your credit utilization is high, ask your credit card company to increase your limit.

Other Credit Guidelines and Requirements

Lenders consider more than just your credit score. Here are some other factors they may review:

• Bankruptcy and Foreclosure: You’ll need to wait 2-3 years after a bankruptcy or foreclosure to apply for most loans.
• No Credit History: If you have no credit, lenders may accept alternative credit lines, such as rent and utility payments.
• Judgments and Federal Debt: Collections or judgments may need to be paid or set up on a payment plan before you’re approved.

Compensating Factors for Poor Credit

Compensating factors can help make up for having a low credit score. Here are a few examples:

• Large Down Payment: A higher down payment reduces the lender’s risk and can make up for poor credit.
• Low Debt-to-Income Ratio: A lower DTI ratio shows that you’re not overleveraged.
• Stable Employment History: Lenders prefer borrowers with a consistent income history.

Refinancing Options for Borrowers with Bad Credit

There are refinance programs available that don’t require a credit check:

1. Streamline Refinance:
   • Available for FHA, VA, and USDA loans.
   • Does not require a credit check or income verification.
   • Great way to reduce monthly payments.
2. Home Equity Loans and HELOC:
   • Use your home’s equity as collateral.
   • Requires at least a 660 credit score.
   • Higher interest rates for lower credit scores.
3. Cash-Out Refinance:
   • Borrow up to 80% of your home’s value.
   • Requires a 620 credit score.
   • Best for those looking to tap into their home equity.

Non-Traditional Loan Options

For borrowers struggling to qualify for traditional loans due to poor credit, non-traditional loan options like Rent-to-Own and Owner Financing can be viable alternatives. These methods provide more flexibility and allow potential buyers to build or repair their credit while securing a home.

Rent-to-Own

• How It Works: Rent-to-Own agreements allow you to rent a home with the option to purchase it later. Part of your rent payment may go towards building equity or a down payment.
• Benefits: This option gives buyers time to improve their credit and save for a larger down payment, without the pressure of securing a mortgage right away.
• Things to Consider: Contracts can vary widely, so it’s crucial to have a clear understanding of terms, including the purchase price and timeframe.

Owner Financing

• How It Works: In owner financing, the seller acts as the lender, providing financing directly to the buyer instead of going through a traditional mortgage lender.
• Benefits: Owner financing can be more lenient on credit scores and income requirements. Down payments and terms are often negotiable between the buyer and seller.
• Things to Consider: Interest rates may be higher, and the buyer needs to ensure the seller has no outstanding mortgages or liens on the property to avoid complications.

Both options are ideal for buyers with bad credit who are seeking alternatives to standard mortgage loans, offering a path to homeownership without the immediate need for traditional financing.

Avoid Common Mistakes When Applying for a Mortgage with Bad Credit

Avoid these pitfalls to increase your chances of getting approved:

• Don’t Overextend Your Budget: Borrow only what you can afford.
• Avoid High-Cost Lenders: Be wary of lenders offering high fees and predatory rates.
• Don’t Close Credit Accounts: Closing accounts can reduce your credit score by increasing your utilization ratio.

FAQs on Bad Credit Home Loans

Can I Get a Home Loan with Bad Credit?

Yes, you can get a home loan with bad credit. FHA, VA, and non-traditional loans are some of the best options available. However, you may face higher interest rates and stricter requirements.

What Credit Score is Considered Bad for a Mortgage?

A credit score below 620 is generally considered bad for a mortgage. FHA loans, however, allow for credit scores as low as 500, depending on down payment size.

What is the Minimum Credit Score for an FHA Loan?

The minimum credit score for an FHA loan is 500, but you’ll need at least a 580 score for the 3.5% down payment option.

How Can I Improve My Chances of Getting a Mortgage with Bad Credit?

You can improve your chances by:

• Saving for a larger down payment
• Reducing debt-to-income ratio
• Improving your credit score by paying off debts or disputing errors

What Loan Options are Available for Bad Credit Borrowers?

FHA, VA, USDA loans, non-qualified mortgages, and subprime loans are some options for borrowers with bad credit.

Can I Buy a Home with No Down Payment if I Have Bad Credit?

VA and USDA loans offer no down payment options but have stricter eligibility requirements. These programs are generally available to veterans or rural homebuyers.

What are the Pros and Cons of a Bad Credit Home Loan?

• Pros: Access to homeownership, government-backed loan programs, and potential credit improvement.
• Cons: Higher interest rates, limited options, and possible private mortgage insurance (PMI).

How Long Does It Take to Improve My Credit to Buy a House?

Improving your credit score can take anywhere from a few months to several years, depending on your starting point and the methods used.

Can I Refinance My Home with Bad Credit?

Yes, you can refinance with bad credit through options like FHA Streamline Refinance or Home Affordable Refinance Program (HARP), depending on your loan type.

Are There Homebuyer Assistance Programs for People with Bad Credit?

Yes, many states offer down payment assistance and first-time buyer programs that can help those with bad credit become homeowners. Examples include HUD programs and state-specific initiatives.

The Bottom Line