In this week's ask a credit repair Expert blog, we look at the best mortgage loan options available when you have a poor credit score, even though traditional lending seems out of reach.
The Best Mortgage Loan Options For Poor Credit Score
This week's question comes from James, a current client, who asks:
"Why, even though I have been working to improve my credit score and have saved for a down payment, am I still having trouble getting approved for a mortgage with favorable terms? I've applied to several lenders, not all of them, even after explaining my situation and providing documentation. What could be my best options? I can't figure out where to turn next."
This is far from a unique problem; we've all experienced it! "I've done everything I can think of, but lenders still won't approve me for a decent mortgage."
Is Your Credit Score Really The Only Issue?
The very first aspect to check is if your credit score is truly the main barrier, or if there are other qualifying factors affecting your approval.
It could be that your application appears rejected because you can't meet what you consider the standard requirements. However, that doesn't mean there aren't mortgage options available to you.
For the purposes of this question, I'm going to give you advice on how to deal with both circumstances.
What Are Your Best Mortgage Options?
There are many loan programs specifically designed for borrowers with poor credit scores. Let's discuss the main ones.
Government-Backed Loan Programs
There are government-sponsored programs, both federal and state-level, that could help you secure financing despite your credit challenges.
FHA Loans
The Federal Housing Administration needs borrowers to meet more flexible credit requirements if it is to help them achieve homeownership and ultimately serve communities with limited access to traditional financing.
FHA loans allow credit scores as low as 580 with a 3.5% down payment, and some lenders will even work with scores as low as 500 if you can put down 10%.
You can technically still qualify for conventional financing, but FHA loans will often provide better terms and lower interest rates for borrowers with credit challenges.
If you can improve your credit score even slightly, you'll have access to better FHA terms and lower mortgage insurance premiums.
VA Loans (For Veterans)
In a similar way, if you're a qualified veteran or active military member, VA loans don't have a minimum credit score requirement set by the VA itself. Individual lenders will certainly have their own standards, but many will work with borrowers who have scores in the 580-620 range.
VA loans offer significant advantages like no down payment required and no private mortgage insurance.
USDA Rural Development Loans
An option often overlooked is that USDA loans are available for properties in eligible rural and suburban areas. These loans typically require credit scores of 640 or higher for automated underwriting.
This is a directive that can help you achieve homeownership in qualifying areas with no down payment required.
Lender-Level Accommodations
There could be opportunities with specific lenders that specialize in working with borrowers who have credit challenges.
There may well be portfolio lenders or credit unions in your area that keep loans in-house and have more flexible underwriting standards than traditional banks.
It is something that can be quite beneficial when you need personalized attention and customized loan solutions.
Non-QM (Non-Qualified Mortgage) Programs
The loans you've been denied may have been qualified mortgages with strict debt-to-income requirements, despite you having strong income potential.
For example, if you're self-employed or have non-traditional income sources, non-QM lenders may focus more on your actual ability to pay rather than just your credit score.
Subprime Lending Options
It could be that traditional prime lending isn't suitable for your situation. As a result, subprime lenders may be willing to work with you, though at higher interest rates.
It could also be that these loans require larger down payments, but they can provide a path to homeownership when other options aren't available.
Loan Quality Considerations
There are also factors related to your overall financial profile that could improve your chances of approval.
Strong Down Payment Offsetting Credit Issues
One of the ways lenders will determine if you're worth the risk is through the down payment you can provide. A larger down payment can both reduce the lender's risk and demonstrate your commitment to the purchase. A borrower with a substantial down payment may qualify for better terms despite credit challenges.
Income Documentation Doesn't Support Application
One of the main reasons why a mortgage application gets denied is that your income isn't perceived as stable or sufficient enough.
Lenders will not approve every application they could. They will prioritize borrowers with steady, verifiable income.
If your income documentation is incomplete, or does not really demonstrate stability, your application may be denied even though you can technically afford the payments.
Debt-to-Income Ratio Is Too High
In a similar way, if lenders perceive your debt-to-income ratio to be too high compared to lending guidelines, they may well not approve your application.
Even if you have signaled that you're a serious buyer by providing a pre-approval letter and using a qualified real estate agent, lenders will still make their own assessment as to whether you can handle the monthly payments.
Recent Credit Events
There is also the possibility that your credit report shows recent negative events that are affecting your approval chances.
For example, if you have recent bankruptcies, foreclosures, or short sales that lenders consider too recent, you may not be able to qualify for certain loan programs due to mandatory waiting periods.
Recent credit events are relatively common but usually require specific waiting periods, so it's worth checking each loan program's requirements to rule this out.
Identify Your Best Path Forward
Knowing what loan options are available is only half the battle. Let's look at how you could potentially improve your chances and then how you could secure financing.
Check Credit Union Options
My first suggestion is to check if your local credit union offers mortgage programs for members with credit challenges.
You may not be focusing much on credit unions in your home search, but they often have more flexible underwriting guidelines and may work with you personally rather than relying solely on automated systems.
Go to your local credit unions and speak with a loan officer directly. From here, you will see if they have specialized programs for borrowers in your situation.
Explore Government Program Eligibility
Next, research which government programs you might qualify for. Check your eligibility for each program and see what requirements you can realistically meet.
For example, you could qualify for:
FHA Loans With Credit Score Flexibility
If you can demonstrate stable income and employment history, FHA loans will work with lower credit scores. Under FHA guidelines, you might qualify with "Acceptable credit with compensating factors."
If this applies to your situation, your next step will be to gather documentation of your compensating factors and apply with an FHA-approved lender.
VA Loans (If Eligible)
The VA loan program might tell you that you're "eligible for VA financing with flexible credit requirements."
If that is the case, you know for certain that your military service opens doors to better financing options, and not just higher interest rates, that could help you secure favorable terms.
The VA explains that veterans with credit challenges can still qualify:
"VA loans are designed to help veterans achieve homeownership. While we don't set minimum credit scores, we expect lenders to thoroughly review the complete loan application."
If you are seeing this opportunity, there is a high chance that VA lenders will look at your overall financial picture rather than focusing solely on your credit score, and as such, may approve loans for veterans who demonstrate other strengths.
To take advantage of this benefit, you need to emphasize your stable income and military service record to VA-approved lenders.
USDA Rural Housing Programs
If your property search returns areas eligible for USDA financing, this means you may qualify for rural development loans with competitive rates and no down payment required.
If you are getting this option, you should explore rural and suburban properties that qualify for these programs.
Consider Alternative Documentation Loans
You may discover that your employment situation calls for "bank statement loans" or "asset-based lending programs."
What this means is that lenders will evaluate your ability to pay based on bank deposits, assets, or other non-traditional income verification, despite you having credit challenges.
The way to encourage lenders to approve these applications is to make sure you have strong documentation of your actual financial capacity and income streams.
Essentially, you need to give lenders a reason to look beyond your credit score.
Improving Your Approval Chances
Although your credit may be poor for one or more various reasons, the strategies to improve your approval odds are all pretty similar.
It is likely that there is either a specific loan program that fits your situation, like FHA or VA loans, that you haven't fully explored.
Or, there is an opportunity to strengthen other aspects of your application, which could convince lenders to approve you despite credit challenges.
Start by reviewing government-backed loan options. These will help you to quickly identify if there's a program specifically designed for borrowers in your situation.
Once you have explored these programs, you are most likely looking at ways to strengthen your overall application.
Depending on what you now think is preventing approval, it may be that your application itself needs strengthening, or you need to find lenders who specialize in your situation.
If it is the former, consider increasing your down payment, improving your debt-to-income ratio, and how you can demonstrate financial stability through employment history and savings.
If it is the latter, you may wish to work with a mortgage broker who can help you connect with lenders who specialize in credit-challenged borrowers.
Summary
There will be some research needed to identify whether your credit score is truly the main barrier, or if there are loan programs designed specifically for your situation.
Once you have identified that, you can begin focusing on whether government programs or specialized lenders offer the best path forward for your homeownership goals.
This can be a challenging situation, but the solutions are quite achievable, and the research should hopefully reveal multiple pathways to secure the financing you need.