What to Know About Home Loans for Bad Credit

Lately, there's been a lot of chatter about the housing market. But if you're in the market for a new home and have bad credit, it can be incredibly tough to buy one without some help from your friends. Luckily, we've got your back! And, the good news is that there are plenty of options for you.

First of all, there are actually quite a few more lenders out there than you might think. A lot of people underestimate just how many lenders exist that will work with someone who has poor or no credit history. This is good news because it means that, while getting approved may take longer than you might like, it won't be impossible!

Ready to get started? Here are some quick tips on what to know if you want to start the process of looking for a bad credit home loan (seriously, it’s not as negative as that phrase makes it sound).

What is a Home Loan for Bad Credit?

A home loan for bad credit is a home loan given to people who have a low credit score. Cool. So, what's the difference between a regular home loan and one that's "for bad credit?"  

The home loan for bad credit is not necessarily more expensive to the borrower, but it does carry a higher interest rate. They can also be unavailable at some financial institutions (i.e. banks and smaller/larger lending companies).

An FHA loan is the perfect example of a home loan for bad credit. It’s a loan that’s backed by the Federal Housing Administration. What’s the minimum credit score needed to get an FHA loan? Currently, it’s only 580. 

However, there are certain other requirements you have to meet, like being a first-time homebuyer who hasn’t purchased another home in the last three year (read more about those requirements here).

Why Get a Home Loan for Bad Credit

Most economic analysts agree that owning a home is a pretty effective way to increase your wealth, particularly for low-income households and younger millennials. Truly harnessing the power of this kind of wealth building opportunity, however, requires that you have a good credit score.

In fact, your credit score is the foundation of your wealth. And, accessing home loans with good interest rates is the perfect example of this. Don’t believe us? Just look at the stats. Homeowners have 41 times more wealth than renters do. As a minority, that kind of statistic is absolutely insane. You have the opportunity to increase your wealth by nearly 50%.

This is why you should get a home loan even if you have bad credit. Don’t let the difficult process discourage you. When looking to buy a home with poor or bad credit, it can seem like everything is against you. This is because mortgage lenders rely heavily on your credit score when determining whether to approve you for a home loan. 

Improving your score before you search for loans is a good place to start if you’re feeling overwhelmed. Just look at the difference it can make...

Let’s say you decide to borrow $200,000 in the form of a 30-year fixed mortgage loan. If your credit score is in a higher category, let’s say between 760-850, a lender can charge you 3.307% interest on that loan. That equals a total payment of $877 per month.

Now, let’s say that your credit is lower, between 620-639, for example. A lender now might charge you 4.869% on that loan. While this might not seem like that much of a difference, your monthly payment would now be $1,061. 

That’s the difference of $184 in savings per month and a total of $66,343 in savings over the lifetime of the loan!

How to Qualify for a Home Loan with Bad Credit

Qualifying for a home loan means that you’ll need to meet the requirements of each individual lender you’re speaking to. So, to start the process, we’d suggest just shopping around a bit to get a good idea of what your options are with your current credit score.

Using a mortgage loan calculator or marketplace is a fast and easy way for you to enter your credit score and receive a full list of lenders who will work with that score (along with the interest rates they’d charge to give you the loan you need).

After that, we’d suggest checking out the requirements for an FHA loan. If you’re a veteran, we definitely suggest taking a look at VA loans (in 2021, there’s no limit to the amount you can take out!). USDA loan are another option, but they are loans that you receive through the U.S. Department of Agriculture when purchasing a rural property.

Don’t find that any of those options work for you? In order to qualify for a home loan with poor credit, we’d suggest doing one of the following:

  • Save up for a bigger down payment. With poor credit, a lender is more likely to give you a loan if you have a larger down payment.
  • Get a co-signer. Having a co-signer is like collateral. If you can’t make loan payments, the co-signer is liable (which means the lender gets their cash either way). This is a great option for you. Just make sure you can make the payments or else the co-signer is going to be on the hook for them.
  • Improve your credit score. The easiest way to get approved for a home loan with great interest rates? Improve your credit score! This means making payments on time, using less than 30% of your available credit, and paying off as much debt as possible.

What Are Lenders Looking At?

When deciding whether to approve a home loan or not, mortgage lenders are looking at a few factors. As mentioned, they’re going to definitely look at your credit score. It's made up of a few defining factors, such as payment history, credit utilization, and the length of your credit history.

Aside from your credit score, they look at the other loans (if any) that you currently have. And, they look at your income. As Discover points out, “You don’t necessarily need a high income to qualify for a home loan, but your income will influence the loan amount for which you’re approved.”

When applying for a home loan, you should be searching for a house within a specific price range. This is true regardless of what your credit score is. It’s best not to purchase a home where the mortgage payments, property taxes, and any insurance costs would add up to more than one third of your monthly income.

It’s worth noting that, if you have poor credit, your chances of getting approved for a home loan are going to be better if you are able to make a down payment of at least 20%.

How to Improve your Chances of Getting Approved for a Mortgage

Finally, we’ll leave you with this piece of advice. As Credit Karma mentions, just because you can be approved for a home loan with bad credit doesn’t mean you should take it. As we’ve mentioned above, a higher credit score can unlock some serious savings. 

If you’re approved for a home loan with your current credit score, stop to consider how much you’d be paying over the life of the loan. Still insist that you apply for a home loan now? Shop around quite a bit. Because your credit score is lower, it’s important that you’re getting the best interest rates possible.

Not as insistent that you get a home loan now? Start working on improving your credit score. Lenders do look at other factors. However, this is the one main factor that will affect your application.

Ready to get started? Download the Wealth Stack app for free today to start learning how to improve your credit rating. We have free, fun video courses that will teach you how to build a solid financial foundation in the pursuit of long-term wealth.