How to get a home loan with bad credit

A credit score is a three-digit number that represents your level of risk as a borrower based on your financial history. It’s common for mortgage lenders to check your credit score, which is calculated based on the information that appears on your credit report. Five aspects impact your score, each varying in importance: payment history (35%), debt-to-credit utilization (30%), length of credit history (15%), credit mix (10%), and new credit (10%).

Here’s what they all mean:

• Payment history. This shows whether or not you’ve made payments on time. One late payment can significantly ding your score. One example: A 30-day delinquency can cause as much as a 90- to 110-point drop on a score of 780 for a consumer who has never missed a payment before, according to Equifax.
• Debt-to-credit utilization ratio. This is how much debt you’ve accumulated on your credit cards divided by the credit limit on the sum of your accounts. Credit experts recommend keeping this ratio around 30%. If you’re maxing out your credit cards each month, you could be damaging your credit score in the process.
• Length of credit history. Having a longer credit history raises your score. Since credit agencies look at the age of your oldest account, the age of your newest account, and the average age of all your accounts, you should keep all of your accounts open—even those with zero balances.
• Credit mix. It helps your score to have a combination of different types of credit accounts, including credit cards, retail accounts, installment loans, car loans, and mortgage loans.
• New credit. Each time you apply for a new credit account, you trigger a “hard inquiry” on your credit, which dings your score (typically by five points). So avoid opening multiple credit accounts at the same time. Doing so will lower the average age of your credit accounts and hurt the length of your credit history.

Caveat: Your credit report doesn’t contain your actual credit score. However, your credit card company can most likely provide your score to you for free, or you can contact a nonprofit credit counselor to find out your score (learn how to find one below).

A perfect credit score is 850, but only about 0.5% of consumers reach that number, according to the Fair Isaac Corporation. Once you’re over 740, you’re in the best range for mortgages and should be able to qualify for the best interest rates.

If your score is in the 700s, you should still be able to qualify for an attractive interest rate. For conventional loans, most lenders look for a credit score of at least 620. Ideally, at a minimum, applicants should have at least a 660 credit score to land a decent interest rate and avoid jumping through additional hoops to qualify for a loan.

The length of your credit history plays a big role in your credit score. If you haven’t been building credit since you were 20, or your parents didn’t add you as an authorized user to their credit card, there are still other ways to qualify for a mortgage and begin to establish credibility. If you have a good track record of paying rent on time, experts say that will help. Those habits are usually indicative of a responsible credit user. You can also take out a credit-building loan, which is specifically designed to help you build a credit history.

There are types of mortgages designed to help people with lower credit scores buy a home. Federal Housing Administration (FHA) loans have some of the lowest credit-score requirements at 580 with a 3.5% down payment, for example.

To get your three-digit number up to snuff, start by addressing the financial habits that damaged your score in the first place.

• Pay all of your bills on time each month. This is the easiest way to boost your score. If you need help adjusting your spending habits and designing a budget that makes sense for you, consider meeting with a financial planner (you can find one at NAPFA.org).
• Pay down your credit card debt. Since credit scores are often the result of having a high debt-to-credit utilization ratio, one of the best ways to improve your score is to get rid of existing debt. Many experts use the 30% rule of thumb: Charges to your credit cards shouldn’t exceed one-third of your total available credit limit. You may also be able to raise your score by requesting a credit line increase from your credit card issuer; this would effectively reduce your debt-to-credit utilization ratio. It typically involves just making a phone call or submitting a request online.

Carefully review your credit reports for errors. You’re entitled to a free copy of your credit report every 12 months from each of the three major credit-reporting agencies (Equifax, TransUnion, and Experian).

One in four Americans said they spotted errors on their reports, according to the Federal Trade Commission. The mistake may be something as simple as someone else sharing the same name as you and your bank mixing up your accounts.

If you spot an error, alert the company that issued the credit account immediately. Once the creditor confirms the error, the company will submit a letter to Equifax, TransUnion, and Experian to get the error removed.

If the error is just on one bureau’s report (like a misspelled last name), contact that agency specifically to rectify the problem. Hopefully, you spotted it early in the home-buying process, since it can take time to get errors removed from your report. If you’re already in the process of purchasing a home, ask your loan officer to help you speed up the error removal.

If you’re the one responsible for blemishes on your report, such as a missed payment, contact your creditor and ask for a deletion. While this likely won’t work for a serial late payer, it might be granted if you’re a one-time offender; it also helps if you’ve been a loyal customer.

If the creditor agrees to the deletion, they’ll send letters to the credit bureaus (the same way they do for errors) requesting that the negative information is removed from your report. Then it’s on you to gather documents proving that changes that have been made—such as a new credit card statement or letter of deletion—and then have your mortgage lender request an updated score from the credit bureaus. This process is often referred to as a “rapid rescore,” and can lead to an updated credit score in days instead of months, which can make all the difference when you’re trying to buy a home in a competitive market.

First, you need to understand the difference between a credit-counseling agency and a debt-management company. If you’ve fallen behind on credit card payments, a credit counselor can help you create a plan to pay back your creditors and better manage your money for a relatively low cost. A debt-management company, meanwhile, will negotiate with your creditors to try to reduce the amount of debt you owe—but many debt-management companies charge a large fee for their services.

For most people, a debt-management company probably isn’t the way to go. Whether you should meet with a credit counselor, meanwhile, depends on how complicated your financial situation is and what kind of guidance you want. If you have debt on only one credit card and simply have to pay off the balance, you already know what you have to do to mend your credit score.

If the situation is more complicated (like, you owe money on several credit accounts and don’t know which to pay off first), a session with a credit counselor may help you devise a payoff plan. Some nonprofits, like the Consumer Credit Counseling Service, offer free consultations.

You can talk to a lender to see what rate you may qualify for, but if you’re not quite ready for that, you can use Trulia’s mortgage rates tool to get free rate quotes and compare rates from multiple lenders, anonymously. Simply enter your credit score along with zip code, purchase price, and down payment, and you’ll get the latest rate quotes from up to 100+ lenders, instantly. You can even estimate much savings you’ll get by boosting your credit score. Simply update the credit score to get updated rate quotes for that scenario.

Remember, the interest rate you’ll get depends on many different factors, not just your credit score, but it’s helpful info to have.

Now that you know what interest rate you could potentially get with your credit score, you can start making financial plans for home buying. Learn about the costs of buying a home, and how much home you can afford so you can make sure you’re actually ready to buy.