What are your mortgage options if you have a low credit score and a spouse with a bankruptcy?
Your question involves multiple issues so I am going to answer it in two parts. First, I am going to review the best mortgage programs for borrowers with low credit scores and then I am going to discuss if your spouse should be a co-borrower or if you should apply for the mortgage on your own.
There are several programs that stand out for mortgage applicants with low credit scores including the FHA, HomeReady and NACA programs. We summarize each of these programs below so you can understand why they are a good fit for credit-challenged applicants.
FHA Mortgage Program. The FHA program requires a credit score of only 500 if you make a down payment of at least 10% of the property purchase price and a score of 580 if you make a down payment between 3.5% and 10%. The minimum credit score required for an FHA mortgage is lower than any other conventional or government-backed mortgage program.
The negatives of the FHA program are that you are required to pay an upfront and ongoing mortgage insurance premium (MIP) which increases your closing costs and monthly payment. The program also applies loan limits which cap your mortgage amount.
The good news is that FHA mortgage rates tend to be lower than conventional loan rates which reduces your monthly payment and enables you to qualify for a higher loan amount. Although the program is backed by the government, FHA loans are provided by traditional lenders such as banks, mortgage brokers and credit unions.
The table below shows FHA mortgage terms including interest rates and closing costs. We recommend that you compare proposals from multiple lenders to find the lowest rate and fees.
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HomeReady Mortgage Program. The minimum credit score required for a HomeReady mortgage is 620, which is lower than the score required for other conventional loan programs. Applicants with a limited credit history or non-traditional credit profile may also be eligible for the program. Another positive of the HomeReady program is that you can use non-traditional income sources to qualify for the mortgage including income from boarders and non-occupant borrowers such as a relative.
Downsides of the HomeReady program include a potentially higher mortgage rate than an FHA loan, mortgage limits, applicant income limits and monthly private mortgage insurance (PMI) fees. Please note, however, that the PMI is cancellable when your loan-to-value (LTV) ratio reaches a certain level -- usually 78% to 80%.
The HomeReady program is also offered by traditional lenders. We recommend that you contact multiple lenders in the table below to confirm program availability and eligibility guidelines.
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NACA Mortgage Program. Instead of requiring applicants to meet a minimum credit score requirement, the NACA program uses a character-based credit review process. The NACA program also does not require a down payment and does not charge closing costs or mortgage insurance.
The drawbacks of the NACA program include a more extensive and time-consuming application process, loan limits and an ongoing advocacy requirement for program participants. Plus the program is not available in all states. You can learn more about how the program works and qualification requirements by visiting the NACA website.
Now that you have an understanding of the programs that are good for applicants with low credit scores, the next step is to determine if your spouse should be on the mortgage or if you should apply for the loan as a sole borrower. The answer to that question depends on the type of bankruptcy and when it occurred.
Lenders apply waiting periods following negative credit events such as bankruptcy before you can apply for a mortgage. Following a Chapter 7 bankruptcy the waiting period is four years for a conventional mortgage and two years for an FHA or VA mortgage. Following a Chapter 13 bankruptcy the waiting period is two years for a conventional mortgage and one year an FHA or VA mortgage.
The waiting periods are shorter if you can document that extenuating circumstances such as a job loss or illness contributed to the bankruptcy. For example, if extenuating circumstances apply, the waiting period following a Chapter 7 bankruptcy is two years for a conventional loan, one year for an FHA loan and one-to-two years for a VA loan.
If the waiting period that applies to your spouse’s bankruptcy has already passed and he or she meets the minimum credit score requirement, then it likely makes sense for you to apply for the mortgage together as co-borrowers. As long as your spouse has a good income and relatively low monthly debt expense, then including her or him on the loan should enable you to qualify for a higher mortgage amount.
Use ourTWO PERSON MORTGAGE QUALIFICATION CALCULATORto determine what size loan you can afford
If your spouse is still within the waiting periods, then you should consider applying for the mortgage as sole borrower. In this scenario, you apply for the loan on your own and the mortgage you qualify for is based solely on your monthly gross income and debt expense as well as your credit score and other qualification factors. The downside to this approach is that your spouse’s income is not included in your application which may reduce the mortgage you can afford.
If your spouse’s bankruptcy is within the applicable waiting period but you want to apply for the mortgage together, you should consider a private money loan which is also known as a hard money loans
Private money lenders provide mortgage options if you cannot qualify for a loan with a traditional lender. Many of these lenders do not apply waiting periods following a bankruptcy but charge a significantly higher mortgage rate and closing costs. You may also be required to make a larger down payment to qualify for a private money loan.
Review How a Private Money Mortgage Works
If you decide to apply for a private money mortgage be sure to understand the significantly higher interest rate, costs and potential prepayment penalty, charged by the lender. If possible, we highly recommend that you refinance a private money mortgage with a traditional loan as soon as the bankruptcy waiting period expires and your credit profile improves, taking into consideration any prepayment penalty.
You can use the FREEandCLEAR Lender Directory to search over 3,900 lenders by location and type. For example, you can find top-rated private money lenders in your state.
Sources
"II.A.1.b.ii.(A).(3) Borrower Minimum Decision Credit Score." FHA Single Family Housing Policy Handbook 4000.1. Federal Housing Administration, January 2 2020. Web.
"HomeReady Mortgage Product Matrix." Mortgage Products. Fannie Mae, December 7 2019. Web.
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