Five years ago, there was such a large variety of mortgage loan products that many people with subpar credit could easily qualify for a loan. Today, those options are significantly lower, but consumers who are willing to provide a lot of documentation and a surplus of cash, the situation is far from hopeless.
The days of getting a home loan with no money down are pretty much history, says Elizabeth Blakeslee, associate broker with Coldwell Banker Residential Brokerage in Washington, D.C. "You also don't hear about the no-documentation loans anymore, and self-employed people must supply more documentation of their actual taxable income," she says. In other words, getting any type of loan these days is going to be more difficult even for those with the best of credit.
Bad credit sob stories spurned
Lenders are also less sympathetic to borrowers' financial sob stories. "It used to be that a really good explanation would help mitigate some bad marks on your credit report," Blakeslee says. "That's probably less in the mix now than it was before because so many people have problems."
But some lenders remain willing to work with you if you can show that your financial troubles are behind you. Tacoma, Wash.-based Tanya Peila and her husband Justin filed for bankruptcy in 2003 and lost their home in the process. After renting for three years while they saved money and got their credit scores back to the 600 range, they felt ready to try for homeownership again. "Because of the bankruptcy, we had to show a lot of documentation," Peila, 31, says. Pay stubs weren't enough. "We had to show bank statements for about six months and past tax returns," she says. They got the loan, but they had to pay. Though the best mortgage rates were in the 4 percent and 5 percent range at the time, they ended up with a mortgage slightly above the 7 percent mark.
Government-backed options best
Because Justin Peila had been in the military, the Peilas were able to qualify for a VA loan, an option for veterans and military personnel that's backed by the U.S. Department of Veterans Affairs. But perhaps the best option for people with low credit scores is the FHA loan -- backed by the Federal Housing Administration, says Robert R. Davis, executive vice president of the American Bankers Association. FHA loans typically don't have a minimum credit score eligibility requirement, and many require only a 3.5 percent down payment. But in January, the FHA tightened its rules and announced that those with scores below 580 would need a minimum 10 percent down payment. Those who get a FHA-backed loan will also now have to pay a mortgage insurance premium of 2.25 percent of the loan amount, up from 1.75 percent.
"Even FHA is doing more risk-based pricing," Davis says. "You'll pay more with bad credit through a higher interest rate or a larger down payment."
Boost your bad-credit mortgage odds
Having the right credit score to qualify doesn't guarantee that you'll get a loan. "There are a lot of underwriting considerations that might factor in," Davis says. Among them: employment history, cash reserves and down payment.
Your chances may be better with a local lender than with a broker who sends you a postcard with an 800 number, says Blakeslee. "You want someone who's a known quantity who you can talk to, who can look at your situation, your marketplace and advise you what you need to be able to do to buy a home in that marketplace," she says. A local lender who can put a face to your name can also work with you over time so if you don't qualify immediately, you can revisit the process in six months or a year, Blakeslee adds.
Another avenue to explore is a HUD-approved housing counselor, says Brandon Cornett, publisher of HomeBuyingInstitute, a website for first-time homebuyers. For no cost, such counselors will work with you to identify ways to improve your credit. They often have home buying programs in place with lenders, which could ultimately make it easier for you to get approved for a loan.
Another option that's gained popularity, particularly in today's depressed real estate market, is the rent-to-own option, says Brendon DeSimone, a Realtor with San Francisco-based Paragon Real Estate Group.
"If you have sellers who can't sell their house because the market's not as good as it used to be, they might entertain an option to rent to own because maybe they'll get their price but it's going to take them a year or two to do it," DeSimone says. "In return, the buyer gets a year or two to fix their credit. It could be a win-win."
Once you get approved for a home loan, there's one more step that's particularly important for people with bad credit. You want to make sure the home you buy has some equity so that once your credit score improves, you can refinance at a later date. If you don't, your past financial mistakes could haunt you for the next 30 years. "It might not look like a big difference on a monthly level from a $1,400-a-month mortgage payment to a $1,650 monthly payment, but when you spread it out over the course of the loan, the amount of interest you can pay can be hundreds of thousands of dollars more with that higher interest rate," Cornett says.
As the Peilas continued to rebuild their financial lives, their credit scores climbed back to the upper 700s, and they refinanced to a rate below 5 percent. "We rebuilt," Peila says. "It just took some time."
More from CreditCards.com: