When someone wants to buy a house and applies for a mortgage with another person, everyone’s credit counts. This presents a dilemma when one applicant’s FICO score is less than perfect: how to buy a house with credit problems? Since, for instance, millennials aren’t as quick to getting married, this situation could arise more and more frequently, so let’s look at what to do when one partner has less than stellar credit.
Basically, there are a few solutions, depending on the cause of the low credit score and the overall strength of the loan application. So let’s dig into them and see if this article can help any of my future clients before they begin the loan pre-approval process.
Lenders Look High And Low
Unfortunately, one can’t offset the co-borrower’s poor history with their own pristine past. Worse yet, it is the applicant with the lowest “representative” credit score who determines how much the loan costs or if the couple even qualifies for financing.
What’s a “representative” credit score? It depends. Mortgage lenders almost always pull a “merged” credit report that provides at least two and usually three credit scores from Experian, Equifax and/or TransUnion.
If there are two scores, they use the lowest as the “representative” credit score. With three scores, lenders use the middle one.
Do You Need Your Partner’s Income To Qualify?
Before undertaking a doomed application, you should use a mortgage calculator to see if you can qualify for the loan on your own. If your income is sufficient, you can leave your partner off the mortgage altogether. You can always add him/her to the property title once the mortgage closes. However, doing this gives your partner some ownership interest in the property, while you would be the only one obligated by the mortgage.
If you have a joint bank and investment accounts, this money can be used for the down payment and counted as an asset on the mortgage application. The partner will have to write a letter stating that the borrower has access to 100 percent of the jointly-held funds.
Money in accounts that are solely in his/her name won’t be considered assets available to you under most program guidelines.
HomeReady® And Home Possible® Programs Cut You Some Slack
If income leaves the two partners a little short of being able to qualify for a home loan, they still have options.
Fannie Mae and Freddie Mac lenders both offer a flexible program that allows eligible borrowers to consider income from non-borrowing members of their households.
Under these programs, lenders allow clients to stretch the debt-to-income guidelines. Instead of maxing out at 43 percent, they may be allowed a debt-to-income (DTI) ratio of up to 50 percent.
For instance, suppose the application looks like this:
Gross income: $5,000/mo
Proposed house payment (principal, interest, taxes and insurance): $1,900
Other payments: auto financing, student loans, credit cards, etc.: $500/mo
DTI ratio: $2,400 / $5,000 = 48 percent
That’s too high; the borrower will not qualify for financing under most programs.
If the partner has verifiable income of at least 30 percent of the client’s ($1,500 a month in this case), the lender can approve the loan. The borrower’s DTI can be as high as 50 percent.
HomeReady® And Home Possible® Eligibility
These programs are not available to everyone. Income must be high enough to qualify for financing, but not exceed program limits. (These limits depend on the property location.)
In most cases, the limit is 100 percent of the Area Median Income (AMI). This lookup tool from Fannie Mae lets someone input the property address and determines its income limit.
How To Buy A House With Government Financing
Government-backed mortgages like FHA, VA and (sometimes) USDA offer more flexibility regarding credit scores. If the partner has a low FICO because he/she has a limited credit history, they can probably get a home loan.
If the partner’s bad credit was caused by an event out of their control, they may overcome a low score. Or if the FICO is low because of bad debt management in the distant past, it may be overlooked.
Clients have better luck if they have a low DTI, an emergency savings account, and/or a larger down payment.
However, if the partner’s credit is a long list of missed payments, charge-offs, collections and judgments, the client won’t be able to finance a house with him/her on the mortgage under these programs.
The good news is that government mortgage guidelines do consider the non-borrowing partner’s income as a “compensating factor,” and they may be approved with a DTI of up to 50 percent with good credit.
Non-Prime Alternatives For Co-Borrowers With Bad Credit
Some lenders actually specialize in financing people in this particular situation. For instance, Noble Home Loans can finance FICO scores as low as 530.
The client have to make a larger down payment (at least 15 percent), and interest rates start at about two percent higher than prime home loan rates.
Helping The Partner Improve Their Credit
You may be able to help your partner improve their FICO scores and make them eligible for financing. Here are a few tips for rapidly increasing a score:
Add the partner to your accounts as an authorized user. They don’t actually need to use the accounts, but your payment history will become part of the partner’s credit report and score. If balances are too high, consider making the partner a personal loan to pay them down or off.
A mortgage lender may be able to help if credit reporting errors are causing the low score. This process is called “rapid re-scoring” and is available only through mortgage lenders.
If the partner’s spending habits are not good, you might want to put off buying a home with them until they complete credit counseling or some form of financial education to get their credit use under control.
Of course, every situation is going to be different, so please feel free to contact me anytime you have a question as to what can be done to help assist people in this situation, as it is a fairly common one. I have great resources when it comes to lending institutions and great loan officers that can assist my clients with valuable information regarding credit, credit repair, loan requirements and guidelines.