You may think you understand your credit issues but it is important to review your credit report and scores months before you apply for your mortgage. You may be unaware of credit issues such as a late payment or delinquent credit card account so it is important to thoroughly examine your full credit report and address any new issues you find. In addition to reviewing your credit report, it is also important to know your credit scores before you apply for a mortgage. There are three companies that provide credit scores and it is important to understand what your score is with all three. Lenders review credit scores for all three companies and use the middle score when assessing a borrower’s ability to qualify for a mortgage.
We want to emphasize that you do not need full credit reports from all three companies -- one report is sufficient -- but you should know your credit scores for all three companies. You can use use free services such as annualcreditreport, CreditKarma and credit.com to obtain your full credit report as well as your credit scores. A common question is, does it hurt my credit score when I check my report and the answer is no. You can use these free services on a regular basis without negatively affecting your score. This is especially important if you are taking steps to address specific items on your credit report and you want to track your progress including any improvement in your score.
If you have poor credit, we highly recommend that you review your credit report and scores six months to a year before you apply for a mortgage. Knowing where you stand from a credit standpoint enables you to proactively address potential issues. It can take time for changes to appear on your credit report and to be reflected in your score so the earlier the better when it comes to identifying credit issues and applying for a mortgage.
When you review your credit report, you may find open items including a delinquent bill, late payments or incidents of identity theft including credit card accounts under your name. It is important to identify and address these issues as soon as possible as it may take months for your actions to improve your credit score. You should bring any delinquent accounts current and resolve any disputed late payments.
Additionally, you may want to pay down credit card debt to improve your ability to qualify for a mortgage. The lower your monthly debt expenses, the higher the mortgage amount you can afford. Paying down credit card balances may be especially helpful because the interest rate on the debt is so high. Depending on the number of credit card accounts you have, it may make sense to keep the account open even if the loan balance is paid in full. It is usually recommended to keep at least two credit card accounts open even if they have a zero balance.
Please note that your credit score may continue to be impacted by past negative credit events, such as a late payment or charge-off, for a minimum of twelve months. Additionally, it can take one-to-two months for your credit score to reflect positive credit actions, such as paying down credit card debt
Lenders review your credit report and score to determine your ability to qualify for a mortgage. The higher your score, the more likely you are to qualify for a mortgage and pay a lower interest rate. If your score is too low, you may not be able to qualify for a mortgage and if you do qualify, you may have to pay a higher mortgage rate. Lenders may have some flexibility in how they treat your credit score and the credit issues outlined below but these guidelines represent the starting point from the lender’s perspective. It is important that you understand how your credit profile and these guidelines impact your ability to get a mortgage before you start the process.
Lenders typically require that borrowers have a minimum credit score of 720 to receive the best mortgage rate and loan terms from the lender. Borrowers with lower scores are still able to qualify for a mortgage but their interest rate may be higher. The table below shows FHA mortgage rates and fees for borrower with good credit. Click on the See All Lenders button on the bottom right if the table to review rates based on your specific credit profile.
Issues such a late payments, delinquent accounts or accounts in collection may also hurt your ability to get approved for a mortgage. In some cases you may be required to resolve the issue with the creditor before you are approved. In other cases you may be required to provide a letter of explanation that addresses the circumstances of the credit issue. The type of debt account is also an important factor as guidelines are more flexible for medical and healthcare debt accounts and stricter for mortgages, credit cards and other types of loans. If you have a late payment, delinquent account or similar credit issue work with your lender upfront to determine the best way to address the item. It is much better to discuss the issue with the lender when you apply for the mortgage then for the lender to discover it after you have applied.
There are some major credit issues that typically require the borrower to wait a certain period of time before applying for a mortgage. The waiting periods are different for conventional mortgages (mortgages that are not insured or backed by a government program) and FHA and VA mortgages. Note how the waiting periods for FHA and VA mortgages are shorter than the waiting periods for conventional mortgages, making them a potentially more attractive option for borrowers who have experienced credit issues
Foreclosure: 7 years (conventional) / 2 years (VA) / 2 years (FHA)
Bankruptcy (Chapter 7): 4 years (conventional) / 2 years (VA) / 2 years (FHA)
Short sale: 2 years (conventional)/ 2 years (VA) / 3 years (FHA)
Cured default: 2 years (conventional) / 1 year (VA) / 1 year (FHA)
IRS lien: the borrower may be required pay off the lien or establish a payment plan before applying for a mortgage
Delinquent credit card debt: the borrower typically needs to pay off the debt or arrange a satisfactory payment agreement with the credit card company
The waiting periods are shorter if you have experienced an extenuating circumstance that caused your income to drop for an extended period of time. Examples of extenuating circumstances include a job loss or medical emergency. You are required to provide documentation that verifies that extenuating circumstance as well as a written explanation of the event that caused the hardship. The waiting periods following credit issues for borrowers with extenuating circumstances are below:
Foreclosure: 3 years (conventional) / 1-2 years (VA) / 1 years (FHA)
Bankruptcy (Chapter 7): 2 years (conventional) / 1-2 years (VA) / 1 years (FHA)
Short sale: 2 years (conventional)/ 1 year or none if no late payments last 12 months (VA) / 1 year or none if no late payments last 12 months (FHA)
Cured default: 2 (conventional) / 1 year (VA) / 1 year (FHA)
Please note that borrowers who are at least a years into a court-approved Chapter 13 Bankruptcy program and who meet certain qualification requirements may be able to qualify for a government-backed mortgage program such as an FHA, VA or USDA loan. Borrowers should check with their lender to understand if they are eligible for these programs before their Chapter 13 Bankruptcy is discharged.
Most lenders require that you submit a written explanation that addresses any major issues on your credit report. In most cases the lender includes the explanation as part of your loan application. In advance of applying for a mortgage, you should draft a thoughtful and honest explanation of any credit issues and include any extenuating circumstances such as a job loss or medical emergency that contributed to the event. Additionally, you should highlight any incidents of identify theft or verified fraud that have impacted your credit profile.
The borrower should use the written explanation as a way to “state their case” but try not to be defensive or make unnecessary excuses. The letter of explanation should be factual and to the point. You should also highlight how you addressed the issue and any positive steps you have taken to improve your credit profile. The lender will include your written explanation of the issue as part of your loan application. The more helpful your explanation, the better your chances are of being approved for the mortgage.
After you have reviewed your credit profile and taken steps to address any issues, it is important to understand your mortgage options. There are several mortgage programs that are well-suited for borrowers with bad credit because they permit lower scores or require no score at all. Below we summarize some of the best mortgage programs for credit-challenged borrower.
The FHA Mortgage Program only requires a credit score of 500 if you make a down payment of at least 10%. If you make a down payment between 3.5% and 10%, the minimum required score is 580. The low credit score requirement is why the FHA program is considered to be one of the best mortgages for borrowers with poor credit.
While the VA Home Loan Program does not technically have a minimum credit score and lenders are supposed to review an applicant's complete credit profile, most lenders require a score of at least 620. Because the VA Program applies more flexible qualification requirements it may be possible to qualify for a mortgage with a lower score or a limited credit history.
The USDA Home Loan Program applies a minimum credit score of 640 although borrowers with lower scores may qualify for the program if they can provide supporting documentation that bolsters their application. This process, called manual underwriting, also requires more work by lenders but can be helpful for applicants with credit challenges.
The HomeReady Mortgage Program requires a minimum credit score of 620 but allows lenders to use non-traditional credit profiles. For borrowers with limited or no credit history, lenders can use rental payments, utility bills or other recurring monthly debt payments to establish an applicant's credit-worthiness. The program also enables you to use alternate income sources such as income from boarders or non-borrower household members to qualify for the mortgage.
The Home Possible Mortgage Program Requires a credit score of 660 for a fixed rate mortgage on a single unit property but also allows borrowers with a limited or no credit history to qualify for the program under certain circumstances. In these cases applicants are required to work with lenders to create a non-tradition credit profile based on their on-time payment history for their rent and other monthly recurring bills.
The NACA Mortgage Program does not require a credit score and instead uses a character-based applicant credit evaluation. The NACA Program also enables you to buy a home with no down payment or closings costs but requires borrowers to go through a more rigorous and longer application process.
So there multiple loan programs credit-challenged applicants. Borrowers should be sure to understand how each program works, including qualification requirements and credit score guidelines, to find the one that best meets their needs and situation.
Regardless of your credit profile, we always recommend that you contact multiple lenders to make sure you get the best terms for your mortgage and this is especially the case if you have bad credit. After you have obtained your credit report, reviewed your credit score and developed a written explanation for any credit issues, you should contact at least four lenders to discuss your situation and assess your ability to qualify for a mortgage.
If you have poor credit, contacting lenders can be a frustrating process because many lenders will say no or charge a very high mortgage rate. It is important to understand your lender options and contact different types of lenders including a mortgage broker to understand what is possible given your individual financial and credit profile. Be weary of lenders who make unrealistic promises and search for a lender that provides thoughtful, balanced advice. You are looking for an advocate who takes the time to get to know your personal situation and works hard for you to get your mortgage approved.
After you have gathered feedback from multiple lenders you can decide if you want to move forward and apply for a mortgage. Hopefully you find a lender and mortgage program that meets your needs and you move forward with the mortgage process. Although it may take time and hard work, with some extra effort from both you and the lender, you can overcome your credit challenges and get a mortgage. In other cases it may make sense for you to wait several months or a year to improve your credit profile. With an improved credit score you may have more lender and loan program options plus the ability to get a loan with a lower interest rate and fees.
Use the FREEandCLEAR Lender Directory to find lenders that offer mortgage programs for credit-challenged borrowers.
If you cannot arrange a mortgage through a traditional lender due to credit challenges you may be able to get a loan through a hard money lender, also known as a private lender. Borrowers with poor credit can use a short-term hard money loan, such as a bridge loan, to finance a home purchase and then refinance the hard money loan with a traditional mortgage with a lower interest rate within one-to-two years, after their credit score has improved.
Hard money loans typically charge an interest rate that is 4.0% - 7.0% higher than a traditional mortgage plus much higher lender fees. Additionally, while hard money lenders may permit lower credit scores or applicants who recently exited bankruptcy, they usually apply stricter qualification requirements in other areas. For example, the lender may apply a lower loan-to-value (LTV) ratio which means that the borrower is required to make a greater down payment or equity contribution. Borrowers should be sure to carefully review the loan terms including extra fees, before applying for a hard money loan.
Although a hard money loan is much more expensive than a traditional mortgage it may be the only alternative for borrowers with bad credit who are seeking to buy a home or refinance in the near term. Hopefully it is only a short period of time before the borrower can refinance the loan with a traditional mortgage at a lower interest rate.
Thibos, Megan. “How to deal with “bad credit”—or no credit—when you want to buy a home.” CFPB. Consumer Financial Protection Bureau, March 1 2017. Web.