Bad credit does not always mean that you will not be able to get a mortgage, especially an FHA loan. The general guidelines for this financing option are more relaxed than conventional loans, providing many people with a blemished credit history the chance to be a homeowner again. The key is the factors you provide to the lender. For example, going to a lender with bad credit, a low down payment, and a high debt ratio will likely get you nowhere. Instead, if you have proper compensating factors, you can “make up” for the low credit scores and make yourself look good and responsible in the eyes of the lender.
The first step is to save plenty of money for a down payment. How much money is enough? The answer is not cut and dry – it really depends on the purchase price of the house you wish to own as well as your credit score. As a general rule, any score lower than 580 requires a 10 percent down payment minimum, rather than 3.5 percent. This amount can increase for lower scores or because the lender requires it to make up for the risk that your low credit score provides. If you want the lender to overlook your low score and instead, look at how responsible you are with your finances, have a down payment that speaks volumes – meaning one even higher than 10 percent if possible.
Have a Low Debt Ratio
As you plan to become a homeowner, you need to get your debts in line. In order to get approved for an FHA loan, typically you need a debt ratio lower than 31 percent on the front end and 43 percent on the back end. If you have ratios significantly lower than that, however, you will put yourself in a better position. For example, a borrower with a credit score of 700 can get by with debt ratios around 31/43 or even slightly higher. A person with a score of 550, however, would not. The lender would consider the blemished credit combined with the high debt ratios too risky. On the other hand, a person with that same blemished history, but has debt ratios of 28/35 or something along those lines, will have a better chance at obtaining FHA financing. See what loans you can pay off or which revolving debt you can remove before you apply for a loan in order to make yourself look better.
Show Increased Income
If your income has increased since your difficult financial past, show the lender how much it increased and how you have become responsible with your finances as a result. Even if you have a future increase coming, typically in the next 2 months, lenders are able to use that as a compensating factor. You will need to prove the increase with proper paperwork from your employer documenting the increase, but then you can use it to improve your stance with the lender.
Clean Housing History
Sometimes your credit score matters less than the payments you have been making. The FHA in particular wants to know about your housing payments. They will look back at the last 12 to 24 months to see how many late payments you have made. If you have a clean housing history for that time, it will work in your favor when you try to get a loan. This housing history can be a previous mortgage or it can be rent that is documented by a landlord on an FHA Verification of Rental History form.
Co-Signers can Help
If you cannot come up with enough compensating factors on your own, you can look to a co-signer, but this should be considered very carefully. A co-signer can use his better credit, higher income, and lower debt ratio to help you get an FHA loan, but this also means that he is responsible for the loan. Even though you are making the payments, if you were to default on them in the future, the bank would turn to the co-signor for the money. If no one makes the payments, everyone’s credit is hurt, including the co-signer, even though it is not a loan for his home.
These simple ways can help you become a homeowner with an FHA loan despite its hard and fast rules regarding credit scores and debt ratios. The FHA has some of the most flexible guidelines, making them able to work with most borrowers. The key is to have a solid housing history and have all of your finances organized before you apply. Take the 12 months preceding your desire to purchase a home to get organized and ensure that any debts you are able to pay off get paid off so that your debt ratios and housing payments help your case rather than hurt it.