There is no escaping the fact that that purchasing a home when you have bad credit can be a more complicated process than if you had good credit. However, “complicated” does not automatically mean impossible. The good news is that even with credit problems you may still be able to qualify for a mortgage.
Putting down a larger down payment than is required may potentially lower your overall risk from a lending standpoint.
First things first: What is bad credit? Everyone has their own definition of bad credit, but it’s safe for all of us to agree that bad credit is a credit report or credit score that suggests you are of elevated credit risk, to some extent. Thankfully, there are published mortgage interest rates for credit scores that fall as low as 620, which is about 80 points below the national average, so even bad credit will not automatically disqualify your mortgage loan application. You probably will not qualify for the best rates and, yes, you will likely have to jump through a few more hoops during the application process. But the bright side is that bad credit does not always equal a mortgage loan denial.
In certain circumstances, there may be some "compensating factors" your mortgage underwriter may be willing to consider. Compensating factors may potentially help to offset your less-than-perfect credit history in the eyes of the lender, making your mortgage application a little more likely to be approved despite your elevated credit risk. These factors include:
Showing a lender that you have savings (especially savings that is equal to at least three to six months’ worth of your future mortgage loan payments) might be able to improve your chances for loan approval. These reserve funds could be present in your bank account, your 401K, your IRA, etc.
Lower-than-Normal Debt-to-Income Ratio (DTI)
DTI serves to help a lender to evaluate your capacity to make the monthly payments on the mortgage loan for which you are applying. In other words, it helps your lender decide whether you can afford the loan payments. If your DTI falls well below the maximum DTI allowed by the underwriter, that may bode well for you even if your credit reports and scores are subpar.
Large Down Payment
Putting down a larger down payment than is required may potentially lower your overall risk from a lending standpoint. Lenders love large down payments! It shows that you’re willing to put your own “skin in the game,” financially speaking.
Lengthy Employment History
A stable employment history may bode well for you and could help to strengthen your mortgage application. A long employment history means you’ll likely maintain a steady income stream.
A Lot of Equity
It may potentially work in your favor if your appraisal shows that the home you are purchasing is worth considerably more than you are borrowing.
Showing 12 consecutive months of on-time rental payments can be helpful during the mortgage underwriting process. The catch is that the lender will typically require you to produce 12 months of canceled checks to be used as rental verification. Receipts or letters from landlords are generally unacceptable methods of proof.
It Cuts Both Ways
Every single one of the aforementioned compensatory factors can work against you if you have great credit. So, if you have FICO or VantageScores in the 800s but you have no job, a horrible DTI, no cash in the bank and are asking for a high “loan-to-value” style loan, it may not matter that your credit scores are fantastic.