Bad Credit Vs No Credit
In the eyes of a lender, having bad credit is very different from having no credit. A borrower with no credit score is simply someone who has not held credit-based and/or bureau-reported accounts in the past. They lack an official score even though they may have demonstrated financial responsibility for years.
A borrower with poor credit, on the other hand, is someone who has failed to meet their financial obligations as required. This could mean making late payments, holding delinquent accounts, or carrying too-high of balances. From a lenders perspective, having limited or no official credit history is better than having a history of mismanagement.
Here are some reasons you might not have a credit score.
You Use cash instead of paying for things with traditional credit accounts
This may be something you grew up with, or a byproduct of previous bad experiences with credit. There is also a growing movement of financial advisors who advise against using credit at all.
You havent used credit in the last 24 months
This often happens to elderly people on a fixed income who dont use credit often. Or maybe youre an active duty member of the military who was on an extended tour of duty and didnt use any credit for several years.
You are young and dont have credit experience
Recent high school graduates often fall into this category, as they may not have had any need for credit if theyve been living at home.
You are a new immigrant to the country with no U.S. credit history
What Exactly Is A Credit Score
A credit score is a three-digit number that measures how well you repay debt. In a nutshell, a credit score is an “I love debt” score. It says youve had debt in the past, and youve been tremendous, moderate or awful at paying it back.
Three major credit bureausTransUnion, Experian and Equifaxuse credit-scoring models, like VantageScore and FICO, to come up with a score that ranges from 300850.
But trust us on thisa credit score is not proof of winning financially. Sure, youll meet plenty of folks who brag about their credit score like its some kind of pick-up line . Dont be fooled. A credit score doesnt measure your wealth, income or employment statusit measures your debt.
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Go Through The Underwriting Process
Underwriting is the process that your mortgage lender goes through to verify your income and employment, debt and financial history to decide whether to give you a loan. Under normal circumstances, underwriting includes pulling your credit history to determine your creditworthiness.
Someone without a credit history may be able to go through a manual underwriting process. Manual underwriting is when your lender goes through each financial document by hand rather than using an automated computer process.
Manual underwriting is ideal for someone with no credit because it allows your lender to verify your payment history in other ways. You can request proof of on-time payments from your landlord, insurance company, utility companies and more to show your lender that you pay your bills every month.
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Should You Buy A Home With Poor Credit
Having poor credit could make your home loan more expensive. The best available rates are generally for borrowers with the highest scores. If your credit needs work and you move forward with your mortgage application anyway, you could get stuck with a higher interest rate than necessary for the length of your loan.
Case in point: If you have a credit score of 760 or above, as of this writing, you might qualify for an APR of 3.080% on a 30-year fixed $200,000 mortgage. That would leave you with a monthly payment of $852 for principal and interest, and you’ll pay a total of $106,825 in interest over the life of your loan. But if your credit score is a 620, your interest rate could jump to 4.669%. That, in turn, will give you a monthly payment of $1,033 for principal and interest and leave you paying a total of $172,037 in interest over the life of your loan.
But rates aside, if your credit score is low, you may want to think about why that is before getting a mortgage. Is it simply a matter of not having a lengthy credit history? Or is it because you’re not in a strong place financially and have frequently been late with bills or run up a high tab on your credit cards? If it’s the latter, then it might be a good idea to delay your mortgage application and work to improve not just your score, but also your entire financial picture.
Getting A Mortgage With Bad Credit
If you have bad credit and fear youll face a loan denial when applying for a mortgage, dont worry. You may still be able to get a mortgage with a low credit score. Of course it will depend on a few factors, so your best bet to see if youll qualify for a loan is to talk to a lender. Many lenders will have a conversation with you about your eligibility with no obligation to apply for a loan.
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How To Improve Your Credit Score Before Buying
Yes, you can buy a house with bad credit but you can also buy with excellent credit!
Remember: credit scores are temporary, so you can change them by changing your behaviors. Even slight changes can make significant differences.
So, whether your timeline to buy a home is six weeks, six months, or longer, you can improve your credit in time. Learn more about how to fix your credit score to buy a house.
Here are five simple ways to improve your credit and save money on your mortgage, plus two shortcuts.
New Credit Accounts Inflate Your Debt
Taking on new debt could limit your loan options in another way, too. The new debt will increase your debt-to-income ratio .
DTI measures your total debt payments against your monthly pre-tax income. Mortgage lenders use this number to see how much room is left over in your budget for a mortgage.
The higher your existing debts, the less mortgage youll be approved for. So you want to avoid taking on large debts like a car loan or personal loan in the time leading up to your home purchase unless its absolutely necessary.
Of course, if youre still more than a year out from buying a home, its a great idea to start building up credit. The stronger your credit score and report, the better deal youll get on your mortgage.
You can see our guide to building good credit for tips and tricks.
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Find The Right Loan And Lender
Investigate all your mortgage options, which we’ll cover below. Several of the government-backed loans cater to borrowers with limited credit as they allow lenders to manually underwrite loans.
If you want to land a conventional mortgage, you’ll also need a lender that will manually underwrite your loan. Small lenders and are far more likely than large, corporate lenders to employ manual underwriting. The only way to know for sure is to call lenders and ask about their underwriting process.
Getting A Mortgage With No Credit History
Lenders use computer algorithms to help them process mortgage applications. If youre a low-risk borrower with a high credit score, steady income, low debt-to-income ratio and sizable down payment, these algorithms can approve your loan quickly.
If you do not have a credit history, the process is a bit more tedious. Instead of getting approved by a computerized model, you need to have your application underwritten manually.
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Is It Possible To Get A Mortgage With No Credit
It is possible to get a mortgage without a credit score, but it will require bypassing the automated mortgage application processes used by many lenders in favor of a more time-consuming process called manual underwriting. It will also require you to provide proof that you pay your bills on time by documenting payments not related to debt, such as rent and utility bills.
In contrast to automated mortgage underwriting, which uses credit scores as a “shortcut” to forecast the likelihood of repayment failure, manual underwriting requires a loan officer to personally review your financial documents to determine your creditworthiness. Specific requirements will vary from lender to lender, but you should expect to provide at least a couple years’ worth of evidence that you’ve paid rent regularly and on time, and that you’ve also made timely payments for utilities, cellphone service or other recurring expenses.
You should also expect to document employment, income and perhaps other assets such as savings and investments, as you would in a regular automated mortgage application.
The extra time and expense of manual underwriting have made it relatively uncommon among mortgage lenders, so you may need to hunt around to find willing lenders. Small, local institutions, including credit unions, can be a good place to start . Some online lending sites and specialty mortgage lenders offer manual underwriting as well.
Take Advantage Of Credit
To improve your credit score, you can explore booster programs such as UltraFICO and Experian Boost, which track the movement of cash in your bank account. It can also be a good idea to utilize credit monitoring services. Many banks offer these services, which will help you to get a sense of when and why your score goes up or down.
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The Importance Of A Down Payment
As mentioned earlier, a down payment is a very important part of a mortgage. It may work in your favor if you could make a sizeable one. But why is it so important?
A sizeable down payment reduces the amount of debt on your mortgage. You are essentially making an upfront deposit payment on the property. Which means the remaining value of the home is the value of the debt. The lenders risk is reduced since there is less debt on the mortgage. Mortgages with sizeable down payments have lower interest rates as well. Less debt equals less risk for the lender. They can then offer you a lower interest rate.
Ramsey explains, Normally, we recommend a down payment of at least 10% to 20% of the home price. But if you have no credit score, aim for 20% or more since it reduces the lenders risk and demonstrates your ability to handle money responsibly.
A down payment helps cheapen a mortgage. The down payment itself requires cash, but the effects thereof are profitable. A lowered interest rate reduces the rate at which interest accumulates. Your monthly payments are cheaper and you could possibly settle the mortgage faster.
And So The Manual Underwriting Saga Began
Heres a tip: If youre going to tackle the world of manual underwriting, organize your financial documents.
At minimum, the manual underwriter is going to want to see:
- several years worth of tax returns,
- the last twelve months of all bank statements,
- non-retirement investment accounts statements,
- and pay stubs to show proof of continuing income
In addition, you will need to show that you are credit-worthy using different means. For me, that meant providing payment history from three different sources. I gave the underwriters my payment history for my rent, my electric bill and my cell phone.
They initially wanted letter of credit from the companies stating that my account was in good standing and that I did not have any late payments over the past year. The only company that was able to provide that information was my utility company. The underwriters were OK with that.
Be ready to have your information scrutinized for any unusual activity and to write letters explaining the activity.
After combing through my bank accounts, the underwriter questioned a rather large deposit that had hit my bank account. The deposit was for a GoFundMe campaign we ran for my uncle who was in a car accident. I wrote a letter to explain what happened and included a list of the expenses we paid from that deposit.
I also had to explain a few address changes.
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Increase Your Available Credit
Once you get a better handle on things and have started improving your score, increasing your available credit can help raise it a little faster. You can do this by either paying down balances or making a credit limit increase request. This effort helps increase your credit score because you will decrease your credit utilization, which is a huge factor in determining your score. Remember, its best to have a higher and apply for mortgages.
And guess what: Most credit card companies allow you to request as many increases as you like without it causing a hard pull on your credit.
What Are The Risks Associated With Private Home Loans
In general, the biggest risk youll face when you take a bad credit home loan is being unable to make the monthly mortgage payment. The result may be the loss of your home through foreclosure. Some mortgages are especially risky, including those that charge adjustable rates or interest only,
To avoid this kind of fate, you want to know all the facts concerning a subprime mortgage or home equity loan.
The Home Ownership and Equity Protection Act of 1994 was enhanced in 2013 by a new rule meant to protect consumers who take out high-interest home loans. The 2013 Rule applies to lenders who charge high interest rates .
The Rule applies to mortgages, refinancings, home equity loans, and home equity lines of credit .
The HOEPA was created in 1994 to protect borrowers who take out high-interest mortgages.
Under the 2013 Rule, high-cost lenders must disclose certain information, such as prepayment penalties and other fees. In addition, these lenders must recommend borrower counseling.
A recent study found that certain lenders price their interest charges right below the mortgage rate threshold that triggers the Rule. The study indicates that certain lenders are willing to forego higher interest rates to skirt the HOEPA rules.
The advice to prospective borrowers is to read the fine print before agreeing to a subprime mortgage contract.
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Fha Loan Credit Score Requirements
You can get an FHA loan with a credit score as low as 500. However, if your score is 500 to 579, be prepared to put 10% down. With a score of at least 580, you can put down just 3.5%. FHA loans have the second-loosest credit score requirements after VA loans and are quicker than conventional loans to offer borrowers a second chance after a bankruptcy or foreclosure.
Still, you might find that some FHA lenders will not work with you unless your score is at least 620. Theyre allowed to have their own, stricter requirements. As a result, you may have to put more work into loan shopping if your score is below 620. Most FHA borrowers have credit scores in the 650 to 699 range, as the table below shows.
Have A Good Credit Mix
Mix things up a little by having a varying degree of accounts on your credit file. Like your partner, credit bureaus like to see you mix things up a little bit. By this, we mean that a proportion of your credit score is ranked by how diverse the different types of credit you have been utilizing is.
Examples include:
Revolving accounts
Installment accounts
Open accounts
Increase your variety and your credit score will increase.
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When You Should Ask For A Rapid Rescore
You should ask for a Rapid Rescore when youve taken actions that will boost your credit score, such as paying off a judgment or an account in collections, but your score wont reflect those changes fast enough to benefit your mortgage application.
Rapid Rescore can update your score, well, rapidlynot after the 30 days or more it could take through the usual process. Your lender can request a Rapid Rescore on your behalf, but you cant request it on your own.
Ask For Manual Underwriting
If you have no credit then getting a mortgage will be difficult. One of the main ways you can improve your chances of getting a mortgage with no credit is by having manual underwriting rather than automatic underwriting by computers.
Most bad credit mortgage lenders will do manual underwriting but ensure you ask for it and ask your mortgage broker to request this .
Manual underwriting means a human rather than a computer will assess your mortgage application in much more detail. They will usually ask you follow-up questions and request further documents.
With manual underwriting you can really see the benefits of using a mortgage broker as they will usually have experience of what sort of documents you can submit to make your mortgage application look more appealing.
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When You Should Rent Vs Buy
Your credit score can offer insight into whether you should rent or buy. Lenders use your credit score as a crystal ball to predict how likely you are to repay a mortgage. But they dont actually know you. What do you think about your credit score? Does it say more about the type of borrower you are today or the type of borrower you were in the past?
If you have a bad score because you didnt understand how to manage credit, but youve learned since then because you went through a rough patch, but youre fine now or because a divorce or identity theft trashed your credit, you might be comfortable buying a home now if you can get a loan despite your credit score.
If you have a bad credit score because youre not good at making payments on time or you tend to overspend, renting while you improve your habits is probably the wiser option.
