How to Qualify for a Mortgage with Bad Credit

Having bad credit can make it more challenging to qualify for a mortgage, but it’s not impossible. Lenders look at more than just your credit score when deciding whether to approve you for a loan. By taking some key steps, you can improve your chances of securing a mortgage, even with less-than-perfect credit. Here’s how you can navigate the process and improve your chances of approval.

1. Know Your Credit Score

The first step is to get a clear picture of your credit situation. Lenders typically look at your FICO score, which ranges from 300 to 850. A score below 620 is generally considered “bad” credit for mortgage purposes, though requirements vary by lender.

You can request a free credit report annually from the three major credit bureaus (Experian, TransUnion, and Equifax) at AnnualCreditReport.com.
Review your report for errors that may be unfairly lowering your score. Correcting inaccuracies can boost your score quickly.

2. Save for a Larger Down Payment

A larger down payment can improve your chances of getting approved for a mortgage, even with bad credit. Lenders may see you as less risky if you’re putting down a significant portion of the home’s value upfront.

While a standard down payment is around 20%, if you have bad credit, aim to put down at least 20% to 25%.
Some government-backed loans, like FHA loans, allow lower down payments (as little as 3.5%) but may require additional compensating factors.

3. Explore Government-Backed Loan Programs

Government-backed loans are designed to help borrowers with bad credit or low down payments. These programs are more flexible with credit score requirements and may be your best chance at qualifying for a mortgage.

FHA Loans: Backed by the Federal Housing Administration, FHA loans allow borrowers with credit scores as low as 580 to qualify with a 3.5% down payment. If your score is between 500 and 579, you’ll need a 10% down payment.
VA Loans: If you’re a veteran or active-duty service member, VA loans, backed by the Department of Veterans Affairs, offer flexible credit requirements, often with no down payment required.
USDA Loans: Available to buyers in eligible rural areas, USDA loans can offer 100% financing with low-interest rates. Though credit requirements are typically flexible, a score of at least 640 is preferred.

4. Work with Non-Traditional Lenders

Some non-traditional lenders, such as online lenders and credit unions, offer more flexible lending criteria for those with bad credit. These lenders may look beyond your credit score, considering factors like your employment history, income, and assets.

Credit unions: They often offer lower rates and are more willing to work with borrowers who have less-than-perfect credit.
Subprime lenders: Some lenders specialize in mortgages for borrowers with poor credit, though they may charge higher interest rates and fees.

5. Improve Your Debt-to-Income (DTI) Ratio

Lenders consider your debt-to-income (DTI) ratio when determining mortgage eligibility. Your DTI is the percentage of your monthly income that goes toward paying off debts (credit cards, auto loans, student loans, etc.). If your DTI is too high, lenders may view you as a risky borrower, even if your income is strong.

Target a DTI ratio below 43% to improve your chances of getting approved.
Pay off smaller debts or consider consolidating high-interest loans to lower your monthly obligations.

6. Consider a Co-Signer

If you have bad credit but a close relative or friend with good credit is willing to co-sign the loan, this can increase your chances of getting approved. The co-signer agrees to take responsibility for the mortgage if you default, which reduces the lender’s risk.

Be sure to discuss the arrangement thoroughly with your co-signer, as it could affect their credit if you miss payments.

7. Offer Compensating Factors

Lenders may be more willing to overlook bad credit if you can offer compensating factors that reduce your risk as a borrower. These might include:

High income: Strong, stable income can make up for a low credit score.
Job stability: Being with the same employer for several years shows financial stability.
Liquid assets: If you have significant savings, investments, or other assets, lenders may consider you less risky.

8. Look for a Manual Underwrite

Some lenders offer manual underwriting for borrowers with bad credit. This means that instead of relying solely on automated systems to evaluate your credit, a human underwriter will review your full financial profile to determine your eligibility.

Manual underwriting allows more flexibility, as the lender can take into account your employment history, rent payment history, and other financial behaviors that don’t necessarily show up in your credit score.

9. Consider a Higher Interest Rate or Adjustable-Rate Mortgage (ARM)

If your credit score is low, you might need to accept a higher interest rate to qualify for a loan. Although a higher rate will result in higher monthly payments, it can still give you the opportunity to purchase a home.

Adjustable-rate mortgages (ARMs) may offer lower initial interest rates than fixed-rate mortgages, though the rate can fluctuate after an introductory period.

10. Work on Improving Your Credit Score

While these tips can help you qualify for a mortgage with bad credit, improving your credit score before applying will significantly improve your chances. Here are a few ways to boost your score:

Pay down credit card balances: Reducing your credit card balances can quickly improve your credit utilization ratio.
Make all payments on time: Set up reminders or automatic payments to ensure you don’t miss any due dates.
Avoid opening new credit accounts: Hard inquiries from new credit applications can temporarily lower your credit score.

Final Thoughts

While getting a mortgage with bad credit can be more challenging, it’s certainly possible with the right approach. By exploring alternative loan options, saving for a larger down payment, improving your financial situation, and offering compensating factors, you can improve your chances of becoming a homeowner. Additionally, keep working to improve your credit score, as this will lead to better mortgage terms in the future.