What Determines Mortgage Rates on Bad Credit Loans? – How to get a home loan with bad or low credit

Key Factors Influencing Conventional Mortgage Rates

For Conventional loans, several elements combine to determine the interest rate you’ll receive:

Credit Scores: This is a primary driver. Generally, a higher credit score indicates lower risk to lenders, leading to more favorable interest rates.¹
Debt-To-Income (DTI) Ratio: Your DTI, which compares your monthly debt payments to your gross monthly income, is crucial.² A lower DTI suggests you have more disposable income to cover your mortgage.³
Underwriting System (Manual vs. Automated): The method by which your loan is underwritten can impact rates. Manual underwriting often allows for more flexibility but might come with slightly different rate structures.
Property Type: The type of property (e.g., single-family home, condo, multi-unit, investment property, second home) affects risk, with primary residences typically getting the best rates.⁴
Occupancy (Owner Occupant, Second Homes, Investment Homes): Loans for owner-occupied primary residences generally have lower rates than those for second homes or investment properties, as owner-occupants are perceived as less risky.⁵
Loan-to-Value (LTV): This is the ratio of your loan amount to the home’s value.⁶ A lower LTV (meaning a larger down payment or more equity) reduces lender risk and can lead to better rates.⁷
Loan Size: The overall amount of the loan can also influence the rate.⁸
Geographic Location (City, County, or State): Mortgage rates can vary based on the specific market conditions and regulations in different geographical areas.⁹

Important Note: The statement “Having prior bad credit such as collections, late payments, bankruptcy, foreclosure, and deed-in-lieu of foreclosure, a short sale does not impact mortgage interest rates” is incorrect for Conventional loans and generally misleading for all loan types. While waiting periods apply after such events before you can qualify for certain loans, and some government loans have more lenient credit requirements, these past issues do impact the rates and terms you’ll ultimately receive on all types of mortgages, especially Conventional loans.¹⁰ Lenders absolutely consider your overall credit history and risk profile, which includes these prior events. The subsequent sections of this article correctly contradict this initial claim.

Navigating Mortgage Options with a Low Credit Score

If your credit score is on the lower side, there are still mortgage options available to you.

Government Loans

Government loans are mortgage programs insured by specific government agencies.¹¹ These include:

FHA Loans: Insured by the Federal Housing Administration (FHA).¹²
VA Loans: Insured by the Department of Veteran Affairs.¹³
USDA Loans: Insured by the Department of Agriculture Rural Development.

The Impact on Mortgage Rates for “Bad Credit” Loans

Lenders meticulously assess credit scores to gauge the risk associated with lending to a borrower. A lower credit score signifies a heightened risk for the lender, which translates into:

Higher interest rates: Lenders charge more to compensate for the increased likelihood of default.¹⁴
Stricter loan terms: This can include more rigorous eligibility criteria.
Limited loan options: Borrowers with poor credit may not qualify for conventional loans and will likely need to explore government-backed or Non-QM (Non-Qualified Mortgage) options.
Potential for larger down payments or additional reserves: Some lenders may require these as further compensation for the increased risk.
More stringent income verification.

Does Past Bankruptcy Affect Mortgage Rates?

Prior bankruptcies and foreclosures do affect your ability to qualify for most mortgage types, and while government loans offer more flexibility, they still come with waiting periods. The initial claim in the previous section that these do not impact mortgage interest rates is inaccurate.

Chapter 7 Bankruptcy: For borrowers who have filed Chapter 7 bankruptcy (liquidation), there’s a mandatory 2-year waiting period before they can qualify for an FHA-insured mortgage loan. This 2-year clock begins ticking from the date of the discharge of the Chapter 7 bankruptcy, not the filing date. For Conventional loans, the waiting period is typically 4 years after Chapter 7 discharge.¹⁵
Chapter 13 Bankruptcy: For Chapter 13 bankruptcy (repayment plan), FHA loans may be available after 12 months of satisfactory payments within the plan, provided the borrower receives court permission. The waiting period is from the date of filing, as the discharge happens after the plan is completed (typically 3-5 years).
Foreclosure: For borrowers with a foreclosure, there’s generally a 3-year waiting period from the date of the sheriff’s sale or the date the deed for the foreclosed home is officially transferred out of their name. This transfer date is critical. For Conventional loans, the waiting period after a foreclosure is typically 7 years from the recorded foreclosure date.¹⁶
Deed-in-Lieu of Foreclosure and Short Sale: These also typically have a 3-year waiting period for FHA loans (from the date the deed is transferred or the short sale is completed).¹⁷ Conventional loans have a 4-year waiting period after a recorded deed-in-lieu or short sale.¹⁸

Credit Score Ranges and Illustrative Mortgage Rates (as of 2024)

This table provides a general idea of how credit scores relate to loan qualifications and typical mortgage rates.

Credit Score Range	Loan Qualification	Typical Mortgage Rates
740+	Best loan terms, lowest rates	6% – 7%
680 – 739	Good loan terms, competitive rates	7% – 8%
620 – 679	Higher rates, stricter requirements	8% – 9%
580 – 619	Subprime rates, limited options	9% – 11%
Below 580	Hard money/Non-QM loans likely required	10% – 15%+

Note: These rates are illustrative and subject to change based on lender, prevailing market conditions, and specific loan type.

Lender-Specific Variations in “Bad Credit” Mortgage Rates

It’s a misconception that mortgage rates for “bad credit” borrowers are universally higher than those with excellent credit. While the average will be higher, the exact rate depends significantly on the specific loan program and the borrower’s precise credit profile. For example, FHA-insured mortgage rates for borrowers with lower credit scores are primarily determined by their FICO score. Factors like isolated late payments, collections, judgments, charge-offs, tax liens, or even a high debt-to-income ratio (DTI) do not necessarily directly impact the interest rate on FHA loans once you qualify.

Borrowers with a FICO score of 580 or higher can qualify for FHA loans with a 3.5% down payment.¹⁹ However, a borrower with a 580 credit score will still receive a higher mortgage rate compared to a borrower with a 700 credit score, even on an FHA loan.

Mortgage Options for Borrowers with Lower Credit

Despite a lower credit score, several mortgage programs are structured to accommodate individuals with less-than-perfect credit:²⁰

FHA Loans (Government-Backed)
- Minimum Credit Score: As low as 500 (with a 10% down payment) or 580 (with a 3.5% down payment).
- Typical Interest Rates: Generally slightly higher than conventional loans but often more affordable than pure subprime or alternative options.
- Benefits: Features a low down payment, flexible credit requirements, and relatively competitive rates.
- Considerations: Requires a Mortgage Insurance Premium (MIP) for the entire life of the loan.
VA Loans (For Eligible Veterans)
- Minimum Credit Score: No official minimum credit score set by the VA (though many lenders may require 580+).²¹
- Typical Interest Rates: Often lower than conventional loans, even for borrowers with some credit challenges.
- Benefits: Requires no down payment, no private mortgage insurance (PMI), and offers flexible credit guidelines.
- Considerations: Borrowers must meet specific military service eligibility criteria.
USDA Loans (For Rural Homebuyers)
- Minimum Credit Score: Typically 640, though some lenders might accept lower scores.
- Typical Interest Rates: Comparable to FHA and VA loans.
- Benefits: Requires no down payment and features low mortgage insurance costs.
- Considerations: The property must be situated in a USDA-eligible rural area.
Non-QM Loans (Non-Qualified Mortgage – Alternative Loan Programs)
- Minimum Credit Score: Varies widely, with some borrowers qualifying with scores as low as 500+.
- Typical Interest Rates: Higher than government-backed loans, typically ranging from 9% to 15%.
- Benefits: Offers flexible income verification methods (e.g., bank statement loans for self-employed individuals, asset-based lending, DSCR loans for investors). Can be an option for those with recent significant credit events like bankruptcy or foreclosure without the standard waiting periods of conventional or even FHA loans.
- Considerations: Usually requires a higher down payment (often 20% or more) and involves more flexible, but sometimes more complex, documentation.
Hard Money Loans (Short-Term Solution)
- Minimum Credit Score: No strict requirement, as approval is primarily asset-based (equity in the property).
- Typical Interest Rates: Very high, commonly 10% to 15%+ (or even higher).
- Benefits: Known for fast approval processes and asset-based lending.
- Considerations: Extremely high interest rates and fees; generally best suited for temporary financing, such as property flipping, where the loan is repaid quickly.

Higher Rates for Lower Credit Scores

It’s a reality that borrowers with FICO scores below 580 will face higher mortgage rates. This is because lenders directly link lower credit scores to a greater risk. Borrowers who are sensitive to mortgage rates should prioritize improving their credit scores significantly before applying for a mortgage.

The Option to Refinance Later

If you purchase a home with a higher mortgage rate due to a less-than-perfect credit score, you can potentially improve your credit profile over time and then refinance to a lower interest rate in the future.

When to Consider Refinancing:

Refinancing could be a smart financial move if:

Your credit score has demonstrably improved (typically by 100+ points).
Prevailing mortgage rates have decreased since you obtained your initial loan.
You have built at least 20% home equity, which could allow you to eliminate Private Mortgage Insurance (PMI) on conventional loans.

Mortgage Rates on Conventional Loans

For Conventional mortgage loans, there’s a direct correlation: the higher your credit score, the lower your interest rate.²² While FHA loans allow individuals who filed for bankruptcy two years ago or experienced a foreclosure three years ago to qualify, Non-QM loans offer an alternative without any fixed waiting period requirements after bankruptcy or foreclosure.²³ Most Conventional loan programs impose significantly longer waiting periods: typically 4 years after a Chapter 7 Bankruptcy discharge, a recorded deed-in-lieu, or a short sale, and 7 years after a recorded foreclosure date.

Strategies to Secure Lower Mortgage Rates with a Lower Credit Score

Even with a less-than-perfect credit score, you can take steps to increase your chances of obtaining a more favorable interest rate:

Improve Your Credit Score Before Applying:
- Actively dispute any inaccuracies on your credit report that might be dragging down your score.
- Commit to paying all bills on time to build a positive payment history.
- Avoid new credit inquiries in the months leading up to your mortgage application, as these can temporarily ding your score.²⁴
Save for a Larger Down Payment: A higher down payment (e.g., 10% – 20%) reduces the lender’s risk and can potentially qualify you for better terms.²⁵ While government-backed loans like FHA allow for down payments as low as 3.5%, putting more money down can significantly reduce mortgage insurance costs.
Consider a Co-Signer or Joint Applicant: A co-signer with strong credit can bolster your application and potentially help you secure a lower rate.²⁶ Adding a spouse or family member with a higher credit score as a joint applicant may also improve your approval odds.
Shop Around for Lenders: Don’t settle for the first offer. Compare rates and terms from multiple lenders, including mortgage brokers, credit unions, and non-QM lenders. Some lenders specialize in mortgage programs for those with less-than-perfect credit and might offer more competitive terms.²⁷
Work With a Mortgage Broker: Mortgage brokers have access to a wide array of loan programs and can help connect you with lenders whose offerings align best with your credit profile.²⁸ They may also be able to negotiate more favorable terms than you could achieve on your own.
Explore a Temporary Buydown: Some lenders offer 2-1 or 3-2-1 buydowns, which allow you to begin with a lower interest rate that gradually increases over the first few years.²⁹ This can be beneficial if you anticipate improving your credit and refinancing before the rate adjusts significantly.

Frequently Asked Questions: Mortgage Rates for Lower Credit Scores

Can I get a mortgage with a low credit score?
Yes, loan options exist for borrowers with low credit scores, including FHA, VA, USDA, and Non-QM loans.30 However, you may encounter higher interest rates and more stringent lending requirements.
How does my credit score impact my mortgage rates?
A lower credit score signals a higher risk to lenders, which typically results in higher interest rates.31 Improving your score is key to securing better terms.
What is the minimum credit score required for a mortgage?
This depends on the loan type. FHA loans can accept scores as low as 500 (with a higher down payment), whereas conventional loans generally require a minimum of 620.
Are there strategies to lower my mortgage rates with a low credit score?
Yes, you can improve your chances by increasing your down payment, actively improving your credit score, comparing offers from various lenders, or considering a co-signer.
Can I refinance later if I obtain a high-interest loan due to bad credit?
Yes, if your credit score improves, market mortgage rates decrease, or you build at least 20% home equity, refinancing could help you secure a lower rate.
Which loan options are best for borrowers with lower credit?
FHA loans are a common choice for those with lower credit scores.32 VA and USDA loans offer excellent terms for eligible borrowers.33 Non-QM and hard money loans serve as alternatives for those who don’t qualify for traditional financing.34
Will a larger down payment help if I have less-than-perfect credit?
Absolutely. A larger down payment reduces the lender’s risk and can significantly help you qualify for a better interest rate.35
How much higher are mortgage rates for those with lower credit?
Mortgage rates for those with lower credit can be anywhere from 1% to 5% higher than prime mortgage rates, depending on your specific credit score, the loan type, and the lender.
Can I qualify for a mortgage soon after bankruptcy or foreclosure?
Yes, but strict waiting periods apply. FHA loans can allow approval one year after a Chapter 13 bankruptcy (with court approval) and two years after a Chapter 7 discharge.36 Non-QM loans may have no waiting period.37
Should I work with a mortgage broker if I have less-than-perfect credit?
Yes, a mortgage broker can be highly beneficial. They can help you identify lenders who specialize in bad credit loans and match you with the best available rates and terms for your unique situation. A broker can also thoroughly explain the nuances of mortgage rates for borrowers with lower credit.