Home Loans for Not-So-Good Credit: A Complete Guide

Mortgage is an invaluable asset for anyone who wants to buy a home. However, you must meet the terms and conditions of lenders to qualify for a mortgage. The credit score is a determining factor when a lender is assessing your eligibility for a home loan, and with a low credit score, getting a mortgage becomes challenging but not impossible. So, let’s look into how to get a mortgage with bad credit.

What Qualifies as a ‘Not-So-Good’ Credit Score?

The credit score is an indication of creditworthiness. It ranges from 300 to 900. The higher your credit score is, the more reliable you are as a borrower.  Credits scores below 650 qualify as not-so-good credit scores. With a score of 680 or above, you have a better chance of getting a mortgage. Click to learn more about the minimum credit score for a mortgage.

Challenges of Getting a Mortgage with Bad Credit

Lenders are reluctant to work with borrowers with low credit scores because of the financial risks. Lenders try to compensate for the risk by increasing the interest rates, which increase your overall mortgage costs.

Moreover, they may demand a larger down payment, at least 20% of the home’s purchase price. Overall, you should meet stricter criteria, and you’d have to go out of your way to prove to the lender that you can pay back the mortgage.

Options for Home Loans with Bad Credit

It’s almost impossible to get a mortgage from prime lenders (i.e., traditional banks) if your credit score is below 680. However, other options exist for getting a mortgage with a low credit score.

Subprime Lenders

Subprime lenders show more flexibility to borrowers with lower credit scores. They are more concerned with the borrower's ability to pay back the loan rather than their credit score. However, subprime lenders charge higher interest rates and additional fees, such as administrative costs.

Co-Signed Mortgages

If your financial resources don’t suffice to apply for a mortgage, you can turn to trusted friends or relatives to co-sign the mortgage application. Through co-ownership, you can secure a lower interest rate and a smaller downpayment, but both parties are equally responsible for the loan. This means that a missed payment damages the financial records of both the borrower and the co-signer.

Private Mortgage Lenders

Private lenders are also more lenient in granting you a mortgage with bad credit. In addition, private mortgage lenders process your application more quickly. However, on the minus side, they charge higher fees and offer shorter repayment terms.

Alternative Solutions: Rent-to-Own Agreements

Under a rent-to-own agreement, you can rent a house with the intention of buying it later. By paying an option fee, which is 1-5% of the home purchase price, you secure the right to buy the home later. Also, a portion of your monthly rent is credited toward the purchase price or future down payment.

This allows you to lock the price and buys you time to build equity. On the other hand, if you decide not to buy the house, you may lose the option fee and extra payments you made with monthly rent.

Improving Your Chances of Getting a Mortgage with Poor Credit

There are ways to help you improve your financial situation and credit score to qualify for a favorable mortgage application.

Save for a Larger Down Payment

A larger down payment makes it easier to pay back the mortgage. Additionally, it shows your commitment to making the purchase, which proves to the lender that you’re a low-risk applicant. By paying at least 20% of the home price for a downpayment, you don’t need to pay for mortgage default insurance, which significantly cuts costs.

Reduce Your Debt-to-Income Ratio

As part of processing your application, the lender assesses your financial situation. This assessment includes your debt-to-income (DTI) ratio, which indicates how much of your income goes into debt repayment. You should keep your DTI ratio below 43% to increase your chances of approval. Paying off smaller debts or consolidating loans can improve your DTI ratio.

Work on Improving Your Credit Score

Improving credit score isn’t difficult, but it takes time. By following simple steps, such as paying your bills on time and reducing credit card balances, you can increase your credit score. You should also monitor your credit report to correct any errors. A high credit score conveys your financial discipline and qualification for a mortgage. Click to learn more about improving your credit score.

Seek Pre-Approval with Multiple Lenders

There is no harm in negotiating with multiple learners as long as you’re transparent about your financial situation and there are no discrepancies in your financial records. Working with different lenders allows you to compare mortgage terms and choose the best lender.

 By getting pre-approved with several lenders, you get one step ahead, and when you find the right house, you can close the purchase more quickly. Click to learn more about the Toronto mortgage pre-approval process.

Frequently Asked Questions

What is a hardship loan?

The hardship loan is a facility for those who are dealing with financial problems such as job loss or medical emergencies. It can provide short-term financial relief.

What type of loan doesn’t require a good credit history to obtain?

Loans from private lenders often have fewer strings attached, but they demand higher interest rates. Also, secured loans that require collateral, like a vehicle, don’t require a good credit history.

Can you get a $5000 loan with bad credit?

You can find lenders who can give you small personal loans even with a bad credit score. In the worst-case scenario, if you can find a lender, you provide collateral or a co-signer to secure the loan.

What is Canada's average credit score?

Any score between 650 and 700 is considered an average credit score in Canada.

Does cancelling a loan affect your credit score?

Canceling a loan can temporarily lower your credit score, especially if it affects your credit utilization ratio or payment history. You should discuss the implications with the lender before you cancel the loan.

The Bottom Line

Getting a mortgage with a credit score lower than 650 is challenging but not impossible. You can use solutions like co-ownership or rent-to-own agreements to become a homeowner. Furthermore, you can improve your financial situation by decreasing your DTI ratio and increasing your credit score to qualify for a favorable mortgage plan.