How to Qualify for a Mortgage with Less-Than-Perfect Credit

Less-than-perfect credit doesn't have to hold you back from qualifying for a mortgage—it's possible.

"Even with credit issues, there are various strategies to get a mortgage," said Aaron Brown, a Loan Officer at New American Funding's (NAF) Novi, Michigan branch.

Exploring government-backed loans, working with an experienced lender to boost credit scores quickly, and using other strategies can improve borrowers' chances of home loan approval.

Explore government-backed loan programs

Federal Housing Administration (FHA) loans are popular among first-time buyers with low credit scores. The FHA insures these loans and requires a lower down payment. Veterans Affairs (VA) loans are for veterans and their families, requiring no down payment. United States Department of Agriculture (USDA) loans are for rural homebuyers and also come with no down payment requirement.

The FHA insured 75% of their home loans to borrowers with credit scores below 680 and down payments under 5%, according to its 2023 annual report. First-time homebuyers made up 82% of total loans, around 478,000, making FHA loans popular for individuals with less-than-perfect credit and first-time buyers.

Understand credit score requirements

Each type of home loan has its specific credit score requirements. For most Conventional loans, lenders prefer a score of at least 620.

However, government-backed loans like FHA, VA, and USDA are more lenient, often accepting scores as low as 580.

"If you have a lower credit score, try first to get over 580, which is the bare minimum for an FHA loan," said Brown. Consumers can check their credit score for free using services like Credit Karma, Credit Sesame, or their credit card provider. Regularly checking your credit score helps you understand where you stand.

Lower your debt-to-income ratio

Your debt-to-income (DTI) ratio compares your monthly debt payments to your monthly income. A lower DTI ratio is more appealing to lenders.

To improve your credit score before applying for a mortgage, aim to pay off as much outstanding debt as possible, make all payments on time, and avoid opening new credit accounts. While it may not be possible to pay off everything, these steps can greatly improve your credit profile and increase your chances of securing a better mortgage rate.

"Keeping your monthly revolving debt paid on time and trying to pay a little more than the minimum can significantly impact your credit score," said Brown. "Also, keep your credit card debt under 35%."

Consider a co-signer

A co-signer with good credit can improve your loan application. This person agrees to share the responsibility of the loan, making you a less risky borrower.

Brown explains that if a borrower carries a lot of debt without the income to balance it, asking a relative to co-sign can help qualify for a mortgage. The borrower can always refinance to remove the co-signer later.

"About 65% to 70% of my first-time buyers use co-signers to qualify for a mortgage," said Brown. "It allows them to qualify from a debt-to-income ratio perspective and can greatly help get approved."

Demonstrate stable income and employment

Lenders look for reliable income and a steady job history. They usually require proof of employment for at least the past two years, along with income documentation. If there are gaps in employment history, having valid reasons, such as further education or temporary layoffs, and explaining how financial obligations were handled during those times can be helpful.

For those who own their own business, have a larger amount of debt, or have income with many deductions, Non-QM (Non-Qualified Mortgage) loans can be an option. These loans offer other ways to prove enough income to pay a mortgage.

Look into state and local first-time homebuyer programs

Many states and local governments offer programs to help first-time homebuyers with less-than-perfect credit. These programs often provide down payment assistance, lower interest rates, and other benefits.

To find state-funded grants, contact your state's housing finance agency. Local governments and non-profits also provide down payment assistance, grants, and loans. Your Loan Officer can guide you through the process and recommend specific programs you may qualify for.

Be prepared to explain credit issues

"Work with a lender that offers manual underwriting. Many don't. Lower scores often require a bit more digging," said Amber Ernst, a New American Funding Loan Officer in Bettendorf, IA.

If you have any blemishes on your credit report, be ready to explain them to your lender. Life happens—medical emergencies, temporary job loss, and other unexpected events can affect your credit. Lenders often understand if you provide context for these issues and will work with you to find a solution.

"Having less-than-perfect credit doesn't mean homeownership is unattainable," said Brown. "There are steps to make it happen."

^{Aaron Brown NMLS # 1890086}

^{Amber Ernst NMLS # 406037}