Bad Credit? You Might Still be Eligible for a Home Loan

Learn About Government Home Loan Programs for People With Bad Credit

People in the mortgage world divide loan applicants into three groups:

• Prime: A FICO score of 660 and greater
• Alt-A: A score of 620 to 659
• Subprime: A score of less than 620

In 2011, about 70 percent of purchase money home loans were prime. This means 30 percent were Alt-A or Subprime. If you have less than a 660 credit score, you will find that most lenders of conventional loans avoid the Alt-A and Subprime markets. However, four departments of the US government offer programs for people with less than perfect credit:

• Federal Housing Authority (FHA)
• Veterans Administration
• USDA
• Public and Indian Housing (Section 184)

Getting Your Application Approved

Lenders want to see two things in a borrower: ability to repay a loan; and willingness to repay a loan.

Lenders operate under the assumption that people are creatures of habit. If you repaid loans in the past, it is likely you will repay loans in the future. That is the basis of a credit score — it's a predictive statistic. The higher your credit score, the more confidence the company that created the credit score has that you will repay loans in the future.

You demonstrate your ability to repay a loan by showing three pieces of information:

• Consistent employment history: usually two years at the same employer or in the same profession
• Low debt-to-income ratio: can you show low existing debts so that you can afford the monthly house payment
• A down payment: a minimum of 3.5 percent for FHA loans, and even less for VA, USDA, and Section 184 loans

The details of showing a willingness and ability to repay vary by loan program. However, the key ideas you need to remember are that lenders want to see you prove your willingness and ability to make your monthly payments.

Federal Housing Authority

FHA loans really are not FHA loans at all — they are loans offered by household names in mortgage origination, including Wells Fargo, Bank of America, Chase, Citi, and countless mortgage brokers. The FHA, however, insures the loan and promises to pay the lender if you do not. This lowers the risk to the lender to near-zero, which lowers the net cost of the loan to you.

There are several other advantages to FHA loans, too. The down payment can be as low as 3.5 percent, and most closing costs can be rolled into the loan. The minimum credit score for an FHA loan is 580, but few loans are approved at that credit score. In general, the higher your score the better your chances are of being approved.

Almost everyone is eligible for FHA loans. However, the amount you can borrrow varies based on your locale. See the FHA's form for determining maximum loan amount to learn how much you can borrow.

Veterans Administration

This home loan gurantee program is designed for veterans of military service, some surviving spouses, and officers of NOAA. There is no VA loan limit, but lenders generally limit VA loans to $417,000. Veterans receive a $36,000 to $104,250 entitlement they can use for a down payment. Interest rates vary, but are generally at the market rate.

USDA Rural Loans

Unlike other government departments, the USDA will make loans directly to homeowners. Called a Rural Housing Direct Loan, must have very low or low incomes. Very low income is defined as below 50 percent of the area median income (AMI). Low income is between 50 and 80 percent of AMI. Loans are for up to 38 years for those with incomes below 60 percent of AMI.

A Rural Housing Guaranteed Loan is for applicants who have an income of up to 115% of the median income for the area. Up to 100% financing is available, and fees can be rolled into the loan balance. Terms can be up to 30 years, and the minimum credit score must be 660. See the USDA Guaranteed Rural Housing Loan Program Underwriting Guidelines (PDF) to learn more.

Section 184

The Section 184 Indian Home Loan Guarantee Program is a loan guarantee program for Native Americans living in eligible areas. The down payment is 2.25 percent on loans greater than $50,000 and 1.25 percent on loans less than $50,000. There is no annual mortgage insurance fee, but there is a 1 percent fee paid at closing that can be financed into the loan.