When the Great Recession hit, a crisis in the housing market lead to tighter lending standards leaving millions of consumers out of the home buying process. Today, although the lending market has normalized, the economy remains unstable and many consumers struggle to put together a strong enough application for a loan approval.
Although credit is typically a major consideration, fortunately, lenders rely on more than just your credit score to qualify for a new loan.
The Credit Side of The Loan
Whether you put in an offer for a home or want to have the best chance for a loan approval before applying, here are the basic things you need to know when applying for a home loan with less than perfect credit.
Know Your Credit Parameters. Lenders see credit through different eyes than consumers: The bank wants the lowest risk, represented by higher credit scores. When you have a lower score, the lender sees red flags, and you must convince them you are still a lower risk, despite your score. Credit is a measure of risk. Most home lenders want to see a credit score of 640 or above, with those over 700 commanding the best terms. In some cases, lenders will accept a score as low as 580, with less attractive terms.
Being informed is essential to the process. Begin by pulling your credit report at www.annualcreditreport.com and review it for accuracy. Home loan applications reviewers examine all three credit reports, so it is a good idea to do the same. You have the right to a free credit report once every 12 months through the above website.
After reviewing your report, which will give you a seven-year payment history, check your credit score. A website like Credit Karma offers free scores along with many credit card providers and banks. Recognize that there are many different credit scores, just like there are different models of smartphones, meaning the one you see will likely not be the exact one the lender uses. It will, however, give you a ballpark on where your credit stands.
Explain the Score. Lenders are willing to understand why you have a poor credit score if other factors on the application are strong. Did you have an illness or unemployment, which you have resolved, which will lead to a rising score going forward? Are delinquent marks a year or more behind you? More substantial marks like a foreclosure or bankruptcy typically must be three years or older for consideration.
Take Steps to Improve Your Score. Depending on the factors which bring down your credit score, you may be able to raise the score quickly with a little effort. You could save thousands of dollars on loan costs by raising your score. First, dispute any errors and ensure your credit report accurately reflects your payment history. Settle accounts. While paying off or settling accounts currently in collection may not raise your credit score, they can give you leverage with underwriters. Work with a debt management company to strategically to get collection accounts paid off.
If you have more than 5% for a down payment (enough to cover the down payment, closing costs and the move, consider paying down debt to lower your debt to income, and make your application stronger. You could potentially increase your score, while increasing your borrowing capacity, by reducing debt balances.
Working with Underwriters
Understand the Lending Process. Lenders essentially use a three-legged stool when approving an application: They look at credit, debt to income, and down payment. From there they consider total assets, length of employment, time in the industry and city, and other factors that indicate financial stability. If you are weak in one area (i.e. credit), showing you have other strengths can turn a decline into an approval.
Request Manual Underwriting. As with many industries today, lenders use an automated underwriting system that grants an initial acceptance or decline. If you have reviewed your credit and have other factors that could lead to approval, a manual review of mitigating factors can push the application to approval status. Factors such as showing a years’ worth of on-time rent payments, or longevity on the job, can make a difference on loans just under the minimum thresholds.
Increase the Down Payment. For banks, it is all about risk. When you demonstrate reduced risk, it makes a difference. One way to lower risk to the bank is with a larger down payment: Having an investment in the home increases your likelihood of keeping up with payments. From the lender’s standpoint, the larger the down payment, the lower the risk of default.
Work with the Housing Authority. FHA loans are common for first time home buyers, however, anyone with marginal credit can benefit from the more lenient lending. These homes are more expensive to purchase because of higher fees but can provide an approval when you have a small down payment and less than perfect credit. FHA loans accept credit scores as low as 580 and only require a 3.5% down payment. In addition to FHA loans, state and local programs sometimes offer those in specific occupations (such as firefighters or teachers) or those willing to buy in certain neighborhoods special considerations. ** this is just an add on. Where can it go? VA loans for veterans are also a good source of loans when credit is less than perfect.
Seek Alternative Financing. Private lenders, seller financing, lease to own, and other forms of private funding can accommodate a lower credit score, or give you time to improve the score before finalizing the loan. Look for homes without current leins as the most probable candidates and discuss any financing request directly with the private lender.
A low credit score does not mean you cannot buy a home. It may require more creativity, more flexibility, and more patience, but with stable employment and good money management skills, you can purchase a home of your own.