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Securing a Home Loan with Poor Credit
Buying a home is an amazing experience, but it can also be a stressful experience. And why not? Purchasing a home is one of the largest investments you will ever make!
Buying a home, your dream home to be precise, is a very fundamental component to the “American Dream”. For some home buyers, the process is straightforward: verify your credit, save some money for a down payment, find dependable realtors, get approved for a mortgage, and then find your dream home.
Unfortunately, for many Americans, this portion of the “American Dream” doesn’t come so easy. There are many reasons Americans can’t achieve the purchase of their dream home, but none of them loom larger or have more of an impact than the strength of their personal credit score.
Estimates show nearly 30% of Americans have poor or bad credit. That means millions of Americans have poor or bad credit! You should never become sheepish or embarrassed because of a low credit score. Instead, you can combat your lackluster credit score by becoming educated and proactive. In doing so, you’ll find securing a home loan to be much less troubling.
Understanding credit scores
To best understand your credit score, you need to know exactly what it is and how it is calculated. A credit score is a three-digit number based on a statistical analysis of your credit files. This number is regarded as your creditworthiness.
Though there are various methods for calculating credit scores, FICO is the most widely used, so we will focus on how your FICO credit score is calculated. FICO breaks your score down based on five categories: payment history, amounts owed, length of credit history, credit mix, and new credit.
Payment history (35% of your credit score): whether or not you have paid past credit accounts on time
Amounts owed (30%): total amount you currently owe on credit
Length of credit history (15%): how long your credit accounts have been established
Credit mix in use (10%): mix of credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans
New credit (10%): opening numerous credit accounts in a short period of time represents greater risk
Now that we understand how a score is calculated, you need to know your personal credit score! You are entitled to one free credit report every 12-month period from each of the three credit bureaus: Experian, TransUnion, and Equifax. Once you have received your credit score, you must understand how it ranks.
740 and higher = excellent
661 to 739 = good
601 to 660 = fair
501 to 600 = poor
500 or lower = bad
If you find your credit score to be low and you’re hoping to be approved for a home loan mortgage, there are several things you can do to improve your chances of being approved.
What to do with a poor credit score
For starters, you must be ready to explain your poor credit score to lenders. Poor credit scores can be attributed to various reasons. For instance, some lenders see a difference between irresponsible applicants and those who have suffered from a stretch of unemployment.
Certain types of bills and loans matter. Medical bills and student loans are perceived as less risky reasons for a low credit score than a default on a car.
If you believe your low credit score is simply because a lack of credit history, you can sometimes overcome this with nontraditional forms of credit such as utility and rent payments. If you have a lengthy credit history and a poor credit score you can take a few other steps to raise the likelihood of being approved.
When you’re trying to become approved for a mortgage, you need to prove your credibility, and you can do this by providing proof of recent on-time payments. On-time payments for various bills over the last year or two can help ease lender nervousness.
You should provide all income and financial documentation to your lender. Prepare your most recent tax returns, pay stubs, bank statements, and W-2s. If you have an investment portfolio provide that, too. Allow the lender to search every avenue of income; this will allow them to better understand your financial situation and your debt-to-income ratio.
When you’re credit score is low, down payments are very integral. If your score is hovering around the 600 mark you should be prepared to provide a very substantial down payment, close to 20%. Pairing a large down payment with proof of a cash reserve of six months shows you are a serious home buyer.
Another avenue for becoming approved for a loan with bad credit is receiving help from a co-signer. A co-signer is someone who puts their name on the mortgage to guarantee the debt will be paid if the primary borrower defaults. Typically, a co-signer is used for smaller loans, but they can be used for home loans, as well.
A co-signer could be a parent, relative, or close friend. Using a co-signer with good credit is not always a safe bet; some lenders will only look at the lower of the two credit scores.
Home buyers can also increase their chances of becoming approved for a home loan by utilizing an FHA loan. An FHA loan is a mortgage insured by the Federal Housing Administration. Borrowers with FHA loans pay for mortgage insurance, which protects the lender from a loss if the borrower defaults on the loan. A credit score of at least 580 will allow borrowers to only make a down payment of 580. If you’re credit score is the range of 500 to 579, you will need to make a down payment of at least 10%. If you’re credit score is under 500, you probably will not qualify for an FHA loan.
The Federal Housing Administration is not a lender, you must receive your loan from an FHA-approved lender.
Hopefully, after reading this, you will understand being approved for a home loan with poor credit is a daunting, yet achievable task. At Home Loan IQ, we revel in the fact we can help those of you with poor credit.
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