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    Your credit score plays a huge role in your ability to get to mortgage — not to mention how easy the process is and what interest rates you’ll qualify for.

    Are you worried your credit isn’t good enough?

    You’re not alone. Many would-be homeowners fear their credit scores will mean sky-high rates and massive down payment requirements or, worse, won’t qualify them for a mortgage loan at all. Fortunately, neither of these have to be true — as long as you choose the right loan option.

    Your Mortgage Loan Options if You Have Bad Credit

    If you’re looking to buy a home but have bad, poor, or stressed credit, then choosing the right loan option is crucial. Not only will it make your application process easier, but it could mean the difference between getting that dream home and losing it.

    Unconventional Loans: A Lifeline for Non-Traditional Borrowers

    What is an Unconventional Loan?

    An Unconventional, or non-qualified mortgage, is a type of loan that doesn’t meet the requirements of a “Conventional Mortgage”. This means they may have more flexible underwriting guidelines compared to traditional loans, making them accessible to borrowers who might not qualify otherwise.

    Why Choose an Unconventional Loan?

    Here are some reasons people choose unconventional loans:

    • Bad, poor, or stressed credit: Unconventional lenders accept lower credit scores than traditional lenders, often down to 620 or even 580.
    • Non-traditional income: If you’re self-employed, have commission-based income, or have assets like investment accounts, unconventional loans can consider these sources for income verification.
    • Recent credit events: Unconventional lenders may be more lenient towards borrowers with recent credit issues like bankruptcy or foreclosure.
    • Higher debt-to-income ratio: Traditional lenders typically have stricter DTI ratios, while unconventional lenders may offer more flexibility.

    How Do Unconventional Loans Work?

    Since unconventional loans don’t need to adhere to the same standards as conventional loans, they have more freedom in their underwriting process. This means they might:

    • Consider alternative income verification methods: Instead of relying solely on W-2s, they can consider tax returns, bank statements, and other documents to verify income.
    • Use manual underwriting: This involves a more personalized approach where a human underwriter manually reviews your application and financial situation.
    • Offer higher debt-to-income ratios: Some unconventional loans allow DTI ratios up to 50% or even higher.
    • Accept lower credit scores: While minimum credit scores vary depending on the lender and program, they are generally lower than traditional loans.

    Types of Unconventional Loans:

    There are several types of unconventional loans available, each with its specific qualifications and terms:

    • Bank statement loans: These loans use bank statements to verify income instead of tax returns.
    • DSCR loans: These loans focus on your debt service coverage ratio, which measures your ability to repay your debts.

    Unconventional Mortgages On the Rise:

    • Mortgage Bankers Association (MBA): The MBA estimated that unconventional loans would make up approximately 5% of the total mortgage market in 2023.
    • Fitch Ratings: Fitch estimated that unconventional securitization issuance would reach $30 billion in 2023, representing a small but significant increase from previous years.
    • National Mortgage Professional: An article in National Mortgage Professional suggested that the unconventional market was experiencing a resurgence in 2023, driven by rising mortgage rates and limited availability of affordable housing.

    Beyond by Embrace

    At Embrace, we actually offer an unconventional loan program designed specifically for non-traditional borrowers — those with lower credit scores or who are self-employed. This even includes cash-out refinances.

    Beyond loans can also be used for larger purchases (they go up to $2.5 million), second homes or investment properties.

    FHA loans

    Loans backed by the Federal Housing Administration can be a good choice if you have bad credit. FHA loans allow credit scores as low as 500.

    The one catch? FHA loans require mortgage insurance if you are making a downpayment of 10 percent or less. This tacks on an extra fee at closing and increase your monthly payments.

    Other Government Loans

    In addition to FHA loans, other government loans like VA and USDA mortgages can also be a good move for low-credit borrowers. VA loans, which are designed for veterans and military members, require a credit score of 620 or higher, while USDA loans require a 640. (USDA loans can only be used if you’re buying a house in certain, designated rural areas of the country.) The benefit of both of these is that they require low or even no down payments.

    Other Ways to Help Your Case

    Increasing your credit score is a great way to better your chances at securing a mortgage — but that’s easier said than done, right?

    Actually, maintaining healthy credit is likely simpler than you think. For some people, it may be as easy as pulling your credit report, looking it over, and reporting any errors you find to the credit bureau (Experian, TransUnion or Equifax). For others, it may mean:

    • Paying down your existing debts. Have high credit card bills? Car loans? Student loans? Work on paying down those balances.
    • Always pay on time. Make it a point to pay every bill on time, every time — even if it means automating your payments or setting up a monthly alarm or reminder. Late payments can ding your score significantly.
    • Avoid taking out any new loans or lines of credit. Getting tempting credit card applications in the mail? Rip them up. Thinking of buying a new car? Wait until you’ve closed on your mortgage. Taking out new debt will only hurt your score and your chances of buying a home.
    • Adding a cosigner with good credit. This can significantly improve your chances of approval and potentially lower your interest rate.

    You can also increase your down payment. If you can afford to, consider increasing your down payment. It might help your interest rate, too. For example, an FHA loan can be obtained for as low as 3.5 percent downpayment, however, they require a 10 percent downpayment if your credit score is between 500 and 579. There are a lot of factors that determine interest rate, though, so your credit score may not be the only factor at play.

    You’ll also want to look into state and local programs designed to help first-time homebuyers with down payments.

    The Bottom Line

    The moral of the story is simple: bad credit doesn’t preclude you from buying a home. With the right lender, the right loan option and the right amount of preparation, homeownership is well within reach.

    It’s also important to remember:

    • Buying a home with less than stellar credit may require higher interest rates and stricter loan terms.
    • Be prepared for a longer closing process.
    • Prioritize credit repair and financial management even after securing your home loan.

    So, with careful planning and the right resources behind you, buying a home, regardless of your credit, is not always impossible. By exploring these options and taking steps to improve your financial standing, you can unlock the door to homeownership.

    Want to learn more about our Beyond program for low-credit homebuyers? Contact an Embrace Home Loans team member today.

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