Are you considering getting a mortgage for your dream home? Your credit score could be one of the major considerations for your lenders. A bad credit score can affect your ability to qualify for a loan.
So, before you jump into the home-buying process and start applying for a mortgage, let us clarify the credit score concept and how to deal with a bad credit score.
Grasp the Credit Score Concept
Credit is a financial term that refers to a borrower's ability to receive goods or services before payment with the promise of a future payment. The credit score is a numerical representation of that ability. Lenders evaluate your credit scores to assess the risks of granting your loan. If you have a history of late payments, unpaid debts, or defaults on loans, you might have a bad credit score. Due to this, it might become challenging to obtain credit or a loan.
So, to make your home-buying process easier, maintain a strong credit score! As your credit score improves, your creditworthiness increases, which gives a hint to the lenders that you have a history of responsible borrowing and are more likely to make timely payments. A good score increases your chance of getting a loan and lets you gain good interest rates and mortgage terms.
Know about the Score Elements
You can improve your overall creditworthiness by considering various factors that comprise your credit score.
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Record of past payments
A significant portion of your credit score is your payment history (35%). To maintain a positive credit score, you need to make timely loan and bill payments. -
Utilization of your Credit
30% of your credit score is determined by the utilization of your available credit. By dividing your available credit by your current use, the resultant ratio determines how much available credit you have. A great way to maintain a high credit score is to keep your debt-to-credit utilization ratio at approximately 30%. -
Duration of Credit History
Your credit score includes 5% of your credit history. If you have a long history of bad credit, such as late payments or defaults, it can significantly lower your credit score. -
Credit Portfolio Diversity
The different credit accounts you have (mortgages, loans, credit cards) make up another 10% of your credit score. If you have various credit types, your credit score might be raised accordingly. -
Recent Credit Accounts
10% of your credit score is determined by the new credit you take on. This component looks at the new credit accounts you've opened recently.
The credit score is not given as a numerical figure in your credit report. The latter only has a representation of your credit situation, which can be used by the lender to calculate and give you a number at zero cost. You can also get this calculation from a non-profit credit counselor.
Get Insight into the Ideal Credit Score
Now that we know that a good credit score needs to be maintained for attaining a mortgage with favorable terms, the next question is: what is the ideal credit score? An excellent credit score is 850. However, anyone hardly has it. So, if your score is 740 or more, you would be able to secure a mortgage easily and at favorable terms. Scores in the range of 700 are also acceptable to lenders for offering good interest rates. Many lenders are willing to lend you a conventional loan if you have at least a 620 credit score. Nevertheless, to secure a mortgage easily with interest rates and terms that are beneficial, try maintaining a score of at least 660.
Grab a Loan with a Bad Credit
Even though getting a loan with a low credit score can be difficult, it's certainly not impossible. If you have a low score, there are a few options, like Federal Housing Administration (FHA) loans, which even accept credit scores of 580, and require less or no down payment.
Additionally, you can opt for a co-signer. A co-signer is someone with good credit who is willing to sign on to your loan and take on responsibility for repayment if you're unable to make payments. Finding a co-signer who is financially secure and has a good credit score wouldn’t improve your score but can help improve your chances of loan approval.
Then, you can also look for specialized lenders, which are financial institutions that offer loans specifically for borrowers with bad credit. They may offer loans with more relaxed credit requirements, but these loans often come with higher interest rates.
Let’s look at your loan options if you have a bad credit score:
- Secured Loans:Secured loans call for collateral, which gives lenders the legal authority to seize the collateral in order to recoup their losses in the event that the borrower defaults on the loan. The interest rates on secured loans are typically lower in comparison to unsecured loans due to the added security provided.
- Unsecured Loans: These loans are made solely on the basis of the borrower's creditworthiness and do not require any form of security. Lenders don't have a guarantee that they'll see their money again if the borrower doesn't hold up their end of the deal and pay back the loan. Therefore, the higher interest rates account for the increased risk.
- Payday Loans: The borrower has to pay off this loan with their next paycheck. People who apply for such loans usually have bad credit and require urgent financial assistance. However, because of the high-interest rates, many borrowers end up in a never-ending debt cycle.
- Personal Loans:Although personal loans allow flexibility in how the funds can be used, the borrowers will have to pay higher interest rates than secured loans.
- Credit Union Loans:Credit unions are non-profit organizations that only let their members borrow money. The good thing is that their interest rates and fees are lower compared to regular banks, which makes them a great option for members with poor credit scores.
- Peer-to-peer loans:These are loans that are financed by individual investors instead of big financial institutions. The cool thing about them is that they have more flexible requirements and lower interest rates than conventional loans. Good news for people with bad credit, ain’t it?!
Strategize to Improve your Poor Credit Score
You can attempt to improve your score and adopt relevant strategies, which would in turn increase your chances of getting a home loan. Let’s see how you can bring that boost.
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Credit History & Responsible Behavior
The longer the time of your credit accounts and history, the higher your chances of getting a home loan. Even if are you young, and you haven’t had a long credit history, you can still show the lenders your responsible behavior and credibility, for instance by making rent payments regularly. A credit-building loan can also be a good option for you to improve your credit history. -
Timely Payments
If you settle your bills and credit card debt in a timely manner and decrease your debt-to-income ratio, you can certainly improve your credit score. Considering these habits, your lenders will trust you and grant you a mortgage. -
Remove Credit Report Errors
You should get in touch with the credit bureau right away if you come across any errors on your credit report. The error rectification shouldn’t be delayed, as it can negatively impact your score. -
Contact Credit Counselors
These agencies can help you understand your credit score, develop a plan to improve it, and even help you find lenders who are willing to work with borrowers with bad credit. -
Prepare necessary Documentation
The lenders might demand proof of employment. Be sure to have your pay stubs, tax returns, and other necessary documents ready when you are applying for a loan. -
Research Interest Rates
Learn what interest rates your low credit score allows. This knowledge will make you aware of the rate you should accept for your improved/improving credit score.
Remember that building a better credit history takes time and effort, but it's never too late to start! Even if your credit score is currently low, you can benefit in the long run by taking steps to improve it. You can get your loans approved and that too at better interest rates and terms. So, if you have bad credit, don't give up! With a little patience and effort, you can start building a better credit history today and set yourself up for a smoother financial future.
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