There are many reasons for having a bad credit score, and you might be wondering if you are still able to buy a home, despite your shortcomings. The truth is that there are no rules set in stone when it comes to bad credit home loans. Some lenders may be more lenient than others and, not only you will be able to get a mortgage loan with a bad credit, but you have the possibility of getting good interest rates, as well (Read: 5 Tips for Great Mortgage Rates).
However, having good credit will always be significantly more advantageous. Good credit allows you to receive a good interest rate, have the possibility of making a lower down payment, pay less in fees, and have much more loan options. If you find a lender that is willing to give you a mortgage loan if you have bad credit, you will have to pay a larger interest rate, make a larger down payment, and you will have just a few loan options.
How Credit Scores Affect Mortgage Interest Rates
Finding a lender willing to give you a loan is difficult, but not impossible, when you have a bad credit score. However, the lender which agrees to approve your loan application takes on a large risk, so your interest rate will be higher. For example, if your credit score is in the 600 to 640 range, your interest rate will be 1.6 percent higher than the interest rate that people with higher credit scores will have to pay. The lower your credit score is, the more you will have to pay in interest. A credit score of 500 attracts an interest rate increase of 3.8 percent over the normal rate.
Those whose credit scores are under 500 will have to pay a much higher interest rate, and will not qualify for a 90 percent loan, but only for a 65 percent loan, meaning that they will have to make a 35 percent down payment. If your credit score is much lower than what is considered good, you might want to take a while and try to improve it. That seemingly small difference in interest means thousands and tens of thousands of dollars out of your pocket.
Getting a Bad Credit Home Loan
Getting a home loan when you have bad credit might prove to be a challenge and, even if you find a lender who is willing to give you the loan, the interest rate and down payment will be much higher than if you had a better credit score. Waiting a couple of years and trying to repair your credit might be a better choice than getting a bad credit home loan, but if that is not an option, then here is what you need to know before applying for a mortgage loan.
- Check your credit report. Get a credit report from each of the three major credit agencies. Sometimes, the info on your credit report might be inaccurate, which will significantly hurt your score. Try to find any errors on your credit report and have them corrected.
- Find your loan-to-value ratio. Find out the ratio between the amount that you wish to borrow and the value of the property. This is called the loan-to-value ratio, or LTV.
- Find your debt-to-income ratio. The debt-to-income ratio is determined by dividing the total of all your monthly debt by your monthly income. Your debt-to-income ratio should be 40 percent or less to increase your chances of receiving the mortgage loan.
- Try to repair your credit. If you have any open credit card accounts, try to pay them off on time. Also, try to pay off any other debt that you might have. As you’ve read earlier in this article, even a small difference in credit score can help you qualify for a lower interest rate, which will bring significant savings.
Before applying for a bad credit home loan, make sure that you weigh in your options, find out if it is possible to hang on for a while, and get the loan when your financial situation has improved. Getting a bad credit home loan is possible, but the terms of the loan and the current interest rate will be much less favorable than if you took out a mortgage loan with a good or excellent credit score.