How to Get a Home Loan With Bad Credit

If you’re ready to start house shopping but your financial track record is a bit spotty, you may be on the hunt for home loans for bad credit. Are there really any viable options out there, or will your dream of becoming a homeowner remain out of your reach until you fix your credit?

The reality is that home loans for people with bad credit exist. However, learning how to get a home loan with bad credit can feel daunting.

This guide explores a few practical options for getting approved for a mortgage if your credit score is on the low side. Here’s everything you need to know to take your first meaningful steps toward homeownership.

How to get a home loan with bad credit: Step by step

Getting approved for a mortgage with less-than-stellar credit requires a bit more effort, but the path is clear if you follow certain steps. Here’s how to get a home loan with bad credit.

Step 1: Know your credit score

First and foremost, it’s important to eliminate the uncertainty from your home-buying journey. Find out what your actual credit score is. There are several different apps and monitoring services that can provide you with a look at your score. While your actual score may be off slightly, the estimated score should be relatively close.

Some lenders also offer soft credit checks, which don’t harm your score. While your actual score could be slightly higher or lower, a soft check can serve as a great starting point. 

Anything under 580 is considered poor credit. A score of 580 to 669 is considered fair credit, while a score of 670-plus is considered good. If your score is in the high 700s or into the 800s, you’ll be eligible for the best interest rates available. 

If your score is 580 or higher, you have a real chance of being approved for a loan on a home. However, you may be eligible for a mortgage with a score as low as 500, depending on the lender and the type of loan.

Step 2: Review your credit report for errors

You’re entitled to a free copy of your credit report from each of the three major credit unions each year. You can request all three at once or space them out. If you haven’t requested any of your reports yet and want to evaluate your ability to buy a home, it’s imperative to get those reports.

Once you receive them, carefully review each report to look for errors. You can dispute mistakes like account balances that are incorrect or duplicate accounts.

When an error is removed from your report, it can make a near-immediate impact on your score. Depending on the nature of the error, you could see your score jump by 10 to 20 points or even more. 

Kikoff has a free dispute-letter generator to make the process easier. You can use it to generate, print, and mail letters to Experian and Equifax. Our platform can also help you create a letter and electronically submit it to TransUnion.

Step 3: Explore loan programs for bad-credit borrowers

You don’t need excellent credit for all loan programs. While you may not get access to the best rates, you can find programs that are designed for borrowers with lower scores. 

FHA loans are among the most well-known options, as they provide the most flexibility in terms of credit scores. You could also explore non-qualified mortgages, which don’t conform to Freddie Mac or Sallie Mae guidelines. The downside to non-QM mortgages is that they may include shorter repayment terms, balloon payments, and high interest rates. 

The good news is you can refinance out of a non-QM loan once your credit improves. Just make sure you can reasonably afford the payments and terms of the loan. Otherwise, you could put yourself into a financial bind. 

Step 4: Save for a larger down payment

If you can put more money down, it will make the deal less risky for your lender, as they’ll be letting you borrow less. Additionally, you’ll have more equity in your home compared to deals where the buyer puts the minimum amount down. 

Even increasing your down payment from 3% to 10% can make a huge difference in your approval odds. When talking to lenders, find out whether putting more money down would change their approval decision. For example, going from 3.5% to 10% down with an FHA loan could mean becoming eligible for the mortgage with a lower score. 

Step 5: Consider a co-signor or co-borrower

Sometimes, it’s simply not possible to get approved for a loan on your own. In this case, you’ll need to have a cosigner or co-borrower.

A co-borrower is someone who is purchasing the home with you, such as a spouse. A cosigner is basically lending you some of their creditworthiness and agreeing to cover your financial obligations if you fail to make payments. 

Taking on a co-borrower or cosigner is a big step. Consider this decision carefully before purchasing a home with another person. Many people may be unwilling to cosign for you due to the potential implications on their credit. If you decide to go this route, make sure to choose someone you trust and who trusts you. 

Step 6: Shop around for lenders that work with bad credit

Not all lenders evaluate borrowers the same way. Some specialize in working with low-credit applicants. When looking at different lenders, you’ll want to compare:

• Interest rates
• Minimum credit score requirements
• Fees and closing costs

Comparing multiple lenders could save you thousands of dollars over the life of your loan. 

Can you get a home loan with bad credit? 

Yes, you can absolutely get a home loan with bad credit. While your options may be limited, they’re far from non-existent. Here are some other factors that lenders evaluate when making their decision:

• Income and employment stability
• Debt-to-income (DTI) ratio
• Down payment amount
• Savings and reserves

If you’re a strong applicant in these areas, lenders may be more lenient when it comes to your credit score. However, you’ll likely be required to put down more than the minimum amount. A higher down payment will translate to a lower monthly mortgage payment and thousands in savings.

If you’re able to improve your credit score before applying while checking off some of these other boxes, you’ll be an even stronger applicant. Your approval odds will be much better, and you may qualify for a better interest rate. 

What counts as bad credit for a home loan?

While each lender is different, anything under 670 is usually considered bad credit. 

Lenders still frequently approve borrowers with scores of 620 and up for conventional, USDA, and VA loans. However, interest rates aren’t as competitive. The absolute bottom threshold for FHA loans is 500. If your score is 500-plus, you may be eligible for an FHA home loan.

Some lenders may approve borrowers for a conventional loan with a score as low as 580. If a lender extends such an offer to you, expect to be asked to put more money down, which could range from 10% to 20%. The lender’s approval process is all about minimizing the risk they take on. 

Types of home loans for bad credit

Good lenders will evaluate your eligibility for all major mortgage types, including FHA, VA, USDA, and non-QM. Only active-duty service members, veterans, and select family members are eligible for VA loans. If you don’t meet the eligibility criteria for a VA loan, the lender will focus on the other three options. 

Here’s a closer look at the types of home loans a prospective lender may discuss with you. 

FHA loans

When it comes to home loans for bad credit, FHA mortgages are likely your best bet. Lenders offer more flexible terms for these federally insured loans, as they take on less inherent risk. Additionally, FHA loans qualify for a 3.5% down payment for eligible borrowers.

In terms of minimum credit score requirements, there are two different tiers of FHA loans. If you want to qualify for a 3.5% down payment, you’ll need a minimum credit score of 580, which is 40 to 60 points lower than most other loan options. 

You may be able to qualify for an FHA loan with a score as low as 500. However, the minimum down payment amount jumps to 10% with that option.

Either way, FHA loans offer more leeway than other home loan options. You may be able to qualify with less-than-perfect credit and take advantage of first-time homebuyer assistance programs to help you with the down payment.

The biggest downside of FHA loans is that they require private mortgage insurance if you put less than 20% down.

Unlike conventional loans, the private mortgage insurance on a standard FHA loan doesn’t fall off when you reach an 80% loan-to-value (LTV) threshold. If you take out a 3.5% FHA loan, the only way to get rid of private mortgage insurance is to refinance once you hit the 80% LTV mark. 

If you take out a 10%-down FHA loan, the private mortgage insurance will be removed after 11 years of on-time payments. This type of insurance is assessed based on several factors, including the purchase price of the home. Getting it removed could save you a few hundred dollars per month on your mortgage. 

VA loans

VA loans are eligible to veterans, active-duty service members, and some military families. Their benefits include:

• No down-payment requirement
• No private mortgage insurance
• Flexible credit standards

While there’s no official minimum score, most lenders want to see a score of 580 to 620 or higher. Again, you may be able to qualify for a VA loan with a lower score, but it’s rare.

The benefits of VA loans are worth the wait for eligible borrowers. If you’re close to the credit score threshold, talk to your lender about ways to boost your score. Taking a few months to work on your credit profile can lead to significant long-term savings and a smoother purchasing process.

USDA loans

USDA loans are available for homes in eligible rural and suburban regions. The key benefits include:

• No down-payment requirement
• Lower mortgage insurance costs
• Flexible credit guidelines

Your eligibility depends on the location of the home and the income limits. While there are no minimum credit score requirements for USDA loans, the USDA requires lenders to dig deeper into applicants’ credit history if their score is under 640 for 502 loans, or under 620 for 504 loans. 

The biggest barrier to USDA loan eligibility is the home’s location. If you’re interested in living in a rural area, talk to your lender to learn more about the eligibility requirements. You can also check your eligibility on the USDA’s website.

Non-qualified mortgage loans

Non-QM loans are intended for borrowers who don’t meet traditional lending standards. When evaluating you for a non-QM loan, a lender may look at the following:

• Bank statements
• Alternative or secondary sources of income
• Your unique financial situation

If you have a consistent history of strong revenue and an ability to repay, lenders may consider approving you for a non-QM loan.

Keep in mind that the terms of non-QM loans are structured to favor the lender, which could mean a shorter repayment period, higher interest rates, or both. Balloon payments and adjustable-rate mortgages are a few loan configurations you should be cautious of.

How bad credit can affect your mortgage rate

If you can get a home loan with bad credit, your score will have a noticeable impact on your mortgage rate. Even a small difference in your interest rate can have an outsized effect on your monthly payment. A higher credit score could help you net a lower rate, whereas a lower score will typically result in a higher rate.

Over a 30-year loan, a difference of half a percent in interest could translate to tens of thousands of dollars. Improving your credit before applying is therefore a smart move. 

Other factors that impact your rate include the loan term (e.g., 15-year vs. 30-year) and market conditions. Discuss these variables with your lender so you can choose the right option for your needs.

How to improve your credit before applying for a home loan

Want to strengthen your credit profile and boost your score before applying for a home loan? Here are some tips to get you started:

• Pay Down Existing Debt: Lower your credit utilization to improve your score 
• Make On-Time Payments: Don’t miss payments, as it could tank your credit
• Avoid Opening New Accounts: Too many new credit accounts can indicate risk to lenders
• Build Positive Credit Activity: Demonstrating positive activity is vital for strengthening your profile 

It can also be helpful to report positive behavior, such as on-time rent and utility payments. With Kikoff, it’s easy to report verified rent payments and use this activity to enhance your credit score.

First steps toward building credit

If you have thin credit or are rebuilding after a rough patch, start small. You can open a starter credit account that allows you to showcase a positive history over time. Kikoff’s credit account can help you establish a tradeline without taking on interest-bearing debt.

Next, focus on keeping your utilization rate low. Try to use less than 30% of your available credit limit, and track your credit score over time to see if it is trending upward. Most importantly, aim to be consistent over a long period of time. 

The lower your starting point, the longer it will take to see a solid score. If you’re just making up for a few blemishes on your credit report, you could bounce back in a few months. 

Conclusion

Kikoff is a dynamic credit-building platform devised to help consumers like you improve their credit. It includes a free credit account, a paid subscription option, free dispute tools, and much more. With Kikoff, you’re back in the driver’s seat when it comes to building your credit. 

Add positive payment history to your credit profile with Kikoff.