Many people dream of owning a home, but getting a mortgage from a lender can be a challenging process if you have bad credit. Poor management of financial resources can affect all aspects of your life, from qualifying for a credit card to securing utility services without having to put down a deposit. Knowing how bad credit may affect the home-buying process can help you prepare before you start looking for a home of your own.
Bad Credit Can Lead to Loan Rejections
Mortgage lenders such as banks and credit unions may be unwilling to lend you money if you have bad credit. The minimum credit score needed to buy a home using a conventional mortgage typically ranges from approximately 620 to 650. This is especially the case for first-time homebuyers. A first-time homebuyer has no history of paying a mortgage that a lender can use to mitigate a lower credit score. Buyers who have years-long history of paying a mortgage on time can often find a lender that will overlook some negative information when making a subjective loan decision. In other words, traditional lenders are more likely to hold first-time homebuyers to the minimum criteria, because the borrower has no history of making payments on something that is likely the borrower’s biggest purchase to date.
Borrowers with bad credit have the option of applying for a non-conventional loan, which is a loan secured by a federal agency or government-sponsored organization such as the Federal Housing Administration (FHA). However, even a FHA loan requires a minimum credit score of 580. If your score is below 580, FHA lenders may not approve your loan application without imposing additional requirements.
A credit score is only one piece of the puzzle when lenders consider home loans for bad credit. A lender can reject an application for reasons that may factor into a credit score, such as a recent history of late payments or a past bankruptcy. Even home loans specifically designed for those with poor credit can be rejected based on aspects of their credit histories.
Bad Credit Usually Means a Higher Interest Rate
Lenders typically use an applicant’s credit history and score to help determine the mortgage interest rate offered. If the lender thinks the applicant poses a high risk of default, they may charge a higher interest rate on the loan. If you cannot secure a monthly interest rate that’s affordable over the life of a loan, bad credit could be the reason. You might have to decline the loan because the monthly payment takes up too much of your available income, leaving no room for other expenses and unexpected life events.
Bad Credit Can Price You Out of the Market
When applying for a mortgage, the size of the loan you’re allowed to take out depends on how high a monthly payment you can afford. A higher interest rate means monthly mortgage payments will be higher, even if you borrow less. As a result, bad credit may price you out of your local real estate market because you wouldn’t be able to qualify for a mortgage large enough to meet your needs.
Bad Credit May Require a Larger Down Payment
People with poor credit are typically required to place larger down payments to qualify for better terms on conventional mortgages. Even FHA-insured loans — which allow smaller down payments — come with potentially deal-breaking requirements. Borrowers of a non-conventional FHA mortgage can make a smaller down payment, but they must maintain private mortgage insurance — which raises monthly payment amounts.
Bad Credit May Lead to Higher Insurance Premiums
Mortgage lenders require that borrowers maintain homeowners insurance to protect the house, since it is the asset that secures the loan. When issuing policies, insurance companies in many states are relying even more on insurance scores based on credit data today than they did in the past.
Poor credit can make it hard to get the insurance you need to close the loan. Even if you find a company to insure you, it may set a higher premium than you can afford to account for the additional risk you pose.