Mortgage for someone with bad credit

Written by Anytime EstimateOctober 21st, 20219 minute read

Bad credit reportObtaining a loan with bad credit is dependent on how bad your credit history is. Do you have a lot of unpaid collection accounts? Or are there a few collection accounts with a value of less than $2,000? Are your credit card payments consistently late, or have you only missed one or two in the last 12 months?
Bad credit, like beauty, is in the eye of the beholder. Let's go over the four major types of mortgages and see if your credit is good enough to get a mortgage.

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Bad credit VA home loans

The Veteran's Administration does not have a minimum credit score requirement. The VA allows the lender to set the minimum credit score. The lender has the authority to override the VA approval guidelines. In general, most lenders will require a minimum credit score of 620. A "satisfactory credit risk" is required by the VA.

Here's what the VA says about bad credit:

Adverse Data

Restored Credit: In non-bankruptcy circumstances, acceptable credit is usually deemed reestablished when the veteran, or veteran and spouse, has made satisfactory payments for 12 months after the satisfaction of the last negative credit item.

Assume that a credit report shows a number of unpaid collections, some of which have been pending for many years.

Once the borrower has fulfilled the obligations and has made regular payments on future commitments for at least 12 months, satisfactory credit is restored.

Isolated collection accounts may not necessarily need to be paid off in order for a loan to be authorized.

A credit report, for example, may reflect a large number of acceptable accounts as well as one or two outstanding medical (or other) collections.

While it is desirable in such situations to have collections paid, it is not usually a condition for loan approval.

Collection accounts, on the other hand, must be included as part of the borrower's total credit history, and unpaid collection accounts must be treated as open, current credit.

Borrowers with a collection history must have rebuilt good credit (see previous paragraph) before they may be deemed a satisfactory credit risk.

Disputed Accounts: Lenders may examine a veteran's claim of bona fide or legal defense of outstanding debts until the amount has been reduced to judgment.

Account balances lowered by a court decision must be paid in whole or subject to a repayment plan with a history of on-time payments.

When it comes to outstanding bills or late payments, paying them off after the acceptability of the applicant's credit is brought into question does not alter the applicant's poor payment record.

Finally, the previous advice is not meant to address every conceivable situation.

Lenders should thoroughly review the complete credit history and exercise caution.

For example, if an applicant has a high number of outstanding collections – regardless of when they were created - the borrower's capacity and desire to fulfill commitments is fair to doubt.

If the applicant and/or spouse are found to be acceptable credit risks despite negative credit information, the loan file should contain an explanation of the rationale for the decision by the applicant(s) and the lender's underwriter.

If a lender has any questions regarding a particular case, they should contact the relevant VA Regional Loan Center.

Bankruptcy: The existence of a bankruptcy in the credit history of an applicant (or spouse) does not automatically invalidate the loan.

Create comprehensive information on the bankruptcy's facts and circumstances.

Consider both the causes of bankruptcy and the kind of bankruptcy filing.

A discharged bankruptcy from more than two years ago may be ignored.

If the bankruptcy was discharged within the past one to two years, the applicant or spouse is unlikely to be an acceptable credit risk unless both of the following criteria are met:

• the applicant or spouse acquired consumer goods on credit following the bankruptcy and paid for them promptly; and

• the bankruptcy was caused by circumstances beyond the applicant's or spouse's control, such as unemployment, protracted strikes, uninsured medical expenses, and so on, and the reasons are recorded.

Divorce is not usually considered as being beyond the borrower's and/or spouse's control.

Foreclosures: The existence of a house loan foreclosure (or deed-in-lieu of foreclosure) in the credit history of an applicant (or spouse) does not automatically disqualify the loan.

• Compile detailed information on the facts and circumstances of the foreclosure.

• Adhere to the criteria given for bankruptcies filed under the direct liquidation and discharge provisions of the bankruptcy code.

See the heading "Bankruptcy" above.

If a VA loan was foreclosed on, the applicant may not be able to receive the entire entitlement for the new loan.

Check that the applicant's Certificate of Eligibility shows enough eligibility to satisfy the lender's secondary marketing criteria.

Treatment of Federal Debts: If an applicant is currently delinquent or in default on any debt owed to the federal government, he or she can not be considered a satisfactory credit risk until the delinquent account is brought current or satisfactory arrangements are made between the applicant and the federal agency.

This criterion is satisfied by refinancing a past-due VA loan using an IRRRL.

If an applicant has a judgment lien on his or her property for a government obligation, the applicant can not be considered an acceptable credit risk until the judgment is paid or otherwise satisfied.

SOURCE:Lenders Handbook - VA Pamphlet 26-7

FHA loans for bad credit

If you're not a vet, the FHA may be your best bet for obtaining a bad credit mortgage. Believe it or not, the FHA (Federal Housing Administration) will permit a credit score as low as 500. That's incredible, but, the FHA requires a larger down payment for such a low credit score. Borrowers whose credit scores are below 580 are required to have a 10% down payment. At 580 and above, the minimum down payment is 3.5% (currently). The down payment can be "gifted" by eligible donors. (Read more about FHA down payments and closing costs).

Now for the bad news. The FHA guidelines (rules) can be superseded by the lender. Finding a lender who is willing to take on a borrower with a credit score below 580 will take some work.

Satisfactory Credit: If a borrower has paid all housing and installment debt payments on time in the past 12 months and has only had two 30-day late mortgage or installment payments in the previous 24 months, the underwriter may consider the borrower to have an acceptable payment history.

If the applicant has an acceptable payment history and no substantial bad credit on revolving accounts in the last 12 months, the underwriter may approve the borrower.

The FHA will accept a loan that exceeds the aforementioned limits if the applicant can demonstrate and document exceptional circumstances.
The FHA handbook states the following regarding very poor credit:

The mortgagee (lender) must investigate the borrower's past-due accounts to see whether the late payments were caused by a disregard for financial obligations, an inability to manage debt, or mitigating circumstances.

This analysis must be recorded in the mortgage file by the mortgagee (lender).

Any explanations or proof provided for late payments must be consistent with the rest of the file's contents.

Only if the underwriter (approved person) can demonstrate that the delinquency was caused by mitigating circumstances, would the underwriter accept a borrower with a credit history that does not meet the above-mentioned acceptable credit history criteria.

SOURCE:FHA Handbook 4000.1 - page 255

Collection Accounts: (A collection account is a debt or loan that has been handed over to a collection agency by the creditor.)
The lender must evaluate if the collection account(s) were opened due to the applicant's disregard for financial responsibilities, inability to handle debt, or mitigating circumstances.

For each overdue collection account, the applicant must provide a letter of explanation (accompanied by documentation). The lender may demand payment of the collection account(s) at or before settlement.

Charge Off Accounts: (A charge off account is a debt or loan that the creditor has written off.) The lender evaluates any charge-off accounts in the same way that the collection account criteria do.

Disputed Derogatory Credit Accounts: The FHA recognizes that collection accounts, charge-off accounts, and accounts with late payments within the previous 24 months may be the consequence of disputed medical accounts, disputed negative credit arising from identity theft, credit card fraud, or illegal usage.
The challenged derogatory credit accounts may be removed from underwriting consideration if the borrower can produce a copy of the police report or other evidence to substantiate the cause for the poor credit listing (s).

Judgments: A judgment in a community property state refers to any obligation or monetary responsibility of the borrower and the borrower's spouse, unless specifically excluded by state law or established by a court or other adjudicative authority.

A non-borrowing spouse's judgments must be settled or paid in full in a community property state, with the exception of debts prohibited by state law.

Exception: If the borrower(s) has engaged into a formal agreement with the creditor to make regular payments on the debt and has made on time payments for at least three months, the judgment will not override the FHA-insured mortgage lien.

It should be noted that the borrower cannot advance payments in order to satisfy the required three-month payment minimum.

Bankruptcy: A Chapter 7 bankruptcy does not preclude a borrower(s) from getting an FHA mortgage if at least two years have passed after the bankruptcy discharge and the borrower(s) has established excellent credit (or chosen not to incur new credit obligations).

Exception:A bankruptcy of less than two years, but no less than 12 months, may be acceptable for an FHA loan if the borrower(s) can demonstrate that the bankruptcy was caused by extenuating circumstances beyond the borrower's control and the borrower has since demonstrated a documented ability to handle their financial obligations in a reliable manner.

Foreclosure: If a borrower has had a foreclosure or a deed in lieu of foreclosure within the three years before the date of FHA application case number assignment, he or she is generally disqualified for a new FHA loan.

The three-year term starts on the date of the deed in lieu of foreclosure or the transfer of ownership from the homeowner to the bank or foreclosing institution.

Exceptions: If the foreclosure was caused by "documented" mitigating circumstances beyond the applicant's control, such as the loss of a wage earner or a serious illness, and the borrower(s) has re-established excellent credit after the foreclosure, the lender may waive the three-year requirement.

Divorce is not regarded as a mitigating circumstance.

If the foreclosure was caused by "documented" mitigating circumstances beyond the applicant's control, such as the loss of a wage earner or a severe illness, and the borrower(s) has re-established good credit after the foreclosure, the lender may waive the three-year threshold.

USDA loans for bad credit

The USDA is more stringent on poor credit than the FHA. According to the USDA underwriting guideline, "applicants having verified credit scores of 640 or above to satisfy the minimal credit reputation given indications of unsatisfactory credit" would be considered.

Credit ratings lower than 640 may be accepted by the lender if the applicant can demonstrate that the poor credit was caused by circumstances beyond the applicant's control. USDA home loans are not available to applicants with credit scores of 580 or below.

Non-Federal Judgments: Court-ordered judgments must be paid off before a mortgage is authorized for a guarantee, unless the applicant can produce paperwork demonstrating that on-time payments were made in line with a recorded arrangement with a creditor.

Delinquent Federal Non-Tax Debt: Delinquent federal non-tax debt makes a USDA single-family home loan guarantee ineligible until the delinquency is addressed.

Delinquent Federal Tax Debt: Federal tax liens may be permitted to lapse if the applicant has entered into a legal repayment arrangement with the federal agency owing to make monthly payments on the outstanding obligation and has made on-time payments for at least three months. The applicant is unable to pre-pay planned installments in order to meet the necessary minimum of three months of payments.

SOURCE:USDA Underwriting Manual

Bad credit conventional loan

Conventional mortgages are produced in accordance with the Federal Home Loan Mortgage Corporation's (Freddie Mac) and the Federal National Mortgage Association's (FNMA) standards (Fannie Mae).

Because conventional mortgages are not guaranteed by the federal government, the two companies are much stricter than the USDA loan program.

If a VA, FHA, or USDA mortgage is foreclosed on, the federal government will pay a part of the lender's loss.
Because there is no collateral with a traditional loan, the credit standards are more rigorous.