You know you need good credit to get a mortgage, but what if you don’t have it? Can a large down payment offset the risk of your bad credit?
Some lenders do look at a large down payment as a compensating factor. How much a lender requires may vary by loan program and even lender, though. Lenders typically look at the ‘big picture,’ when qualifying you for a loan. Learn how much a large down payment may help your chances of loan approval.
Are There Mortgages for Borrowers with Bad Credit?
First, you probably want to know if you can even get a mortgage with your bad credit. The answer is that it depends. What is your credit score? Is it below 500? If so, finding a mortgage may be difficult. If it’s just lower than what you hear is ‘good’, which is typically 680, you may have your choice of lenders.
Lenders don’t look at just the credit score itself. They look at your credit history. They try to piece together why you have ‘bad credit.’ Is it because you made some payments late? Or did you make your payments on time, but you overextended your credit? Overuse of your credit can bring a score down quite a bit.
Lenders use this information when making a decision. If they decide that your credit score is good enough to get a loan, but they want some type of compensating factor, a large down payment may be the answer.
How a Large Down Payment Helps
If you do have a low credit score, a large down payment can help offset the risk you pose. When you invest your own money n the home, it shows lenders that you have a vested interest in it. In other words, you may be more likely to make your payments on time so that you don’t lose your own money.
Here’s an example.
Joe buys a home for $150,000 with just 5% down. He has a 640 credit score, but was able to get approved for the loan. Joe’s loses his job and is finding it hard to make his mortgage payments. Since Joe only invested $7,500 of his own money, he may be okay walking away from the home, losing it in foreclosure. While $7,500 is a lot of money, Joe is willing to lose it in order to shake the responsibility of the mortgage during this time.
Jack buys a home for $150,000 as well, but puts 20% down on the home. This means Jack makes a down payment of $30,000. Jack had a credit score of 600, but the higher down payment made the lender feel good about giving him the loan. Jack also loses his job, but he finds a way to make ends meet and make his mortgage payment. The last thing Jack wants to do is lose $30,000.
You can see how a large down payment can sway a lender into giving you a loan. A low down payment combined with a low credit score can be too risky. But, a high down payment with a low credit score can help offset that risk.
Other Compensating Factors
Many lenders require you to have more than one compensating factor when dealing with a low credit score. Since the credit score is one of the driving factors in an approval, lenders often want to know what else you bring to the table, so to speak.
Some of the most common compensating factors outside of the higher down payment include:
- Low debt ratio – Lenders look at the amount of your monthly income that your debts already take up. You need money at the end of each month to cover the daily cost of living. If your debt ratio is too high, you may be forced to sacrifice, which often leads to mortgage default. A DTI of 36% or less often offsets the risk of low credit, though.
- Stable employment – Lenders look for a 2-year employment history at the same job. If you changed jobs within the last two years, a lender may consider it ‘risky.’ They want you to show reliability and stability. The stability of job security can help offset a low credit score.
- Increasing income – Just as stable income is important, so is increasing income. If you can show that you continually improve your finances by making more money each year, it can offset a low credit score. Higher income can mean a lower debt ratio and less risk of mortgage default.
A large down payment can help you get a mortgage if you have bad credit. Don’t worry if one lender turns you down though – keep looking. Each mortgage lender has different guidelines and will accept different risks. Find the lender that will give you the loan you need at the cost you can afford for the greatest outcome.