FHA Loans with Bad Credit – Can I Qualify?
For anyone that is familiar with the mortgage process, we know that credit scores determine your ability to qualify for a home loan… Actually, your credit score will almost always affect whether you qualify for any type of loan, including the amount of money you may be eligible to borrow. Your credit score and the type of loan are two factors that can heavily impact a home owner’s decision of where his or her new purchase will be located. So the question that many homebuyers may ask is: How do I qualify for FHA loans with bad credit?
Prior to browsing for homes or even attempting to obtain any home loans, you should determine and review your current credit reports. The most effective way to go about this is to obtain your credit scores from the top three credit bureaus in the country – Experian, Equifax, and TransUnion.
If you find that you have bad credit scores and that lenders can’t provide you with a high enough loan amount and low interest rates, it may be entirely possible that you won’t be able to purchase a home in the neighborhood you want. In this case, it’s best to come up with a plan on how you can improve your scores to good standing.
Things To Look For When Reviewing Your Credit Reports
When you review your credit reports, you should keep the following in mind:
- Have you made all your payments on time?
- How much of your line of credit have you used?
- Do you have any new credit accounts?
- How long have you owned a credit account?
- How many of these accounts are under your name, and what type and standing are they in?
- Do your credit reports display any errors that need to be disputed?
The answers to those questions should be accurate, as any of them can affect your overall credit scores. If you find any issues with your reports or credit accounts, successfully disputing these should help you maintain or improve your good standing and further solidify your home purchase.
Obtaining your reports and scores from the three main credit bureaus is quite easy, and you’ll also be able to progressively monitor your accounts through them. This will help you remain alert to any issues or changes made to your profile, allowing you to keep your identity and credit scores protected.
5 Steps to Qualify for FHA Loans with Bad Credit
It has been established that you will be offered higher interest rates for your loan if you hold bad credit. If this is the case, the amount of which you are provided with may also be lower. Unfortunately, having higher rates and low loan amounts would mean a prospective home owner most likely can’t afford the high monthly mortgage payments in a more desirable neighborhood. So what is a bad credit score as it relates to home buying? For FHA loans, you should have a credit score that is above 580 and most often above the 600 range.
1. Save your money for a large downpayment.
If your credit score is below 580, a FHA lender cannot allow you the benefit of a 3.5% downpayment requirement. Buyers with bad credit, below 580, should expect to put at least 10% down to purchase their desired home. The greater money you can put down, the lesser risk a lender may see in the transaction. These are things that you can control and may allow you to be successful when you otherwise would not be.
This seems like a no-brainer and it may feel like an uphill battle but ideally your score will range between 660 and 720 according to the Wall Street Journal. Like the downpayment, this is also within your control and it may take some time and effort. Paying your bills on time and consistently will show that you are financially responsible and this plays a big role in the credit score algorithm. As you do this, you effectively pay down balances on credit cards and others lines of credit, improving your debt-to-income ratio. First things first: you have to check your own credit first.
3. Maintain good credit over a two year period.
Ultimately there are no guarantees until you actually speak with a mortgage broker about your personal financial situation. Approval of FHA loans with bad credit are not a certain thing but you do have a good chance. HUD will direct loan underwriters to add explanations for negative items on your credit report to expand on any special situations or things that may not be communicated on your credit report. Special situations like health conditions among others may explain why your credit score is bad or less than perfect.
4. Communicate compensating factors.
To qualify for a FHA loan with bad credit it is helpful to communicate any compensating factors to your lender. If you are unable to qualify for a FHA loan through the automated loan process, it may be helpful to have the loan be manually underwritten and having at least 3 compensating factors is a good standard to live by when seeking an approval this way. Examples of compensating factors may be one of the following:
- Offering a down payment of 10% or greater for your new home
- Restricted/limited credit utilization that shows low credit card balances
- Proving your potential for increased income/earnings such as job training, higher education, or a note from your boss indicating that you are due for a raise
- Lower debt-to-income ratios that are under 41% in total and less than 28% for your housing costs
5. Ask a friend or relative to co-sign your mortgage.
By involving another person in your home purchase, you are effectively altering your risk profile. Another person represents another source of income and other collateral that a lender may go after if you default on payments. Having a co-signer to get approval for a home loan, even with bad credit, is a strong way to gain approval.