If you have bad credit, you might assume that you can’t get a home loan. But, if you have compensating factors, you may get the loan you need. One of the largest compensating factors is a large down payment. Putting your own money into the home can offset the fact that you have a less than perfect credit history.
How Does a Down Payment Help?
A down payment is like investing your own money in the home. It also decreases the amount of money a lender must give you. Decreasing the loan amount decreases the lender’s risk of default. In the eyes of the lender, this is a good thing, which may prompt them to approve your loan despite the low credit score you possess.
How Much Must You Put Down?
The bigger question is just how much money do you have to put down to offset your bad credit? While there isn’t a specific formula, obviously the more money you put down, the better off your chances of getting approved become.
On average, lenders like to see at least 20% of your own money invested in the home. If you have that kind of money, it shows lenders that you have financial responsibility, despite your low credit score. Maybe there is an explanation for your low credit score. If you explain it to the lender (in writing) and combine it with a 20% or higher down payment, you may increase your chances of approval.
Other Compensating Factors That Help
A large down payment isn’t the only factor that can offset bad credit, though. You can combine it with a variety of other factors, such as:
- Stable employment – If you have been at the same employer for several years, it shows lenders consistency. If you hop around from job to job, it shows lenders that you don’t stay put and cannot be relied on for consistency. A stable employment history, on the other hand, can be considered a positive.
- Increasing income – Lenders evaluate your last two years of income. They want to see the pattern. Does your income increase or decrease over that time? If you can show a pattern of increasing income over the last few years, you can show lenders that you are responsible and moving your way up, which can work in your favor.
- Low debt ratio – Lenders also pay close attention to your debt ratio. How much of your money is already spoken for each month? This will affect how the amount of mortgage that you can comfortably afford. The lower your debt ratio is, the higher the mortgage payment a lender can approve you for, even with a low credit score.
Lenders like to look at the big picture. They want to know what type of risk you are overall. They don’t base it on your credit score alone. Of course, if you paired a bad credit score with a high debt ratio and low down payment, you would be considered high risk. If, on the other hand, you paired a bad credit score with a low debt ratio and high down payment, you may have a better chance of securing the loan that you need.