Top mortgage sources if you have bad credit


Looking to buy a home, but your credit isn’t as good as you would like? That’s going to make getting a mortgage a tough task, but it doesn’t mean you’re completely out of luck.

Before you have a reasonable chance of being approved for a conventional mortgage, you need a FICO score of at least 620 (see Investopedia's article "What Is a Good Credit Score?") and probably 12 months of on-time payments of all of your bills. Additionally, your debt-to-income ratio, the amount of your monthly income going to debt payments, probably can’t be higher than 43% of your monthly gross income. Of course, few rules are hard and fast, so take these as general guidelines. If you’re close, it doesn’t hurt to apply.

What if your credit isn’t good enough for a conventional mortgage? There are two other options to consider.

FHA Loan

The Federal Housing Administration, or FHA, is part of the U.S. Department of Housing and Urban Development. The FHA helps home buyers purchase a home without meeting the stringent requirements of a conventional mortgage. Because many such buyers aren’t financially able to pay the sometimes high upfront costs of a mortgage, an FHA loan often comes with lower down payments – as low as 3.5% – lower closing costs and lower credit standards.

The FHA doesn’t make the loan, however. The agency partners with banks and insures part of the loan. If you were to default on the loan, the FHA will pay the guaranteed portion, allowing banks to take a risk on borrowers who may not otherwise qualify.

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You may be able to qualify for an FHA loan with a credit score as low as 580, but lending banks still make the final decision and don’t have to approve applicants with a score that low. Most will require a higher credit score but perhaps not as high as a conventional loan.

Since the mortgage crisis that was blamed for sending America into a recession in 2008, lenders have tightened their standards considerably but don’t let that keep you from applying for a loan. (See Investopedia's "Top Reasons to Apply for an FHA Loan" and Top Reasons To Apply For An FHA Loan and "7 Things to Know About FHA Home Loans.")

Lease to Own

Maybe your credit score is just too low to qualify for a loan, or a 3.5% down payment isn’t something you can afford. Homeowners who can't sell their home at the price they want might consider a lease-to-own option.

Lease to own, also called rent to own, simply means that part of your monthly lease payment is going toward buying the home while the rest is a rent payment. This option may give you time to save for a down payment, rebuild your credit history, and try out the home before committing to purchase.Lease-to-own contracts often last two to five years and have an option to walk away from the home under certain terms.

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You likely won’t find many homes with a lease-to-own option but if you work with a realtor, he or she can do much of the research for you. For more ways to locate one, see Investopedia's article "Finding Rent-To-Own Homes."

The Bottom Line

Sometimes life events send your credit score plummeting. You didn’t plan for it to happen but you’re in the situation nonetheless. If that’s the case, you might have to rent until you can rebuild your financial picture.

If you can qualify for a loan, expect the interest rate and other terms to be less favorable than if your credit score were higher.

Before applying for a mortgage, spend time building your score and saving for a down payment. Sometimes that can take a year or more.