Most couples apply for mortgage loans jointly. But what happens when one of them has bad credit?
Bad credit can be a real problem for married couples who apply for a mortgage together. Typically, the lender looks at the lowest of the two credit scores when deciding what interest rate to charge, so if your spouse has bad credit, your mortgage rates will be affected.
Just because one person doesn’t have a stellar credit score doesn’t mean your homebuying dreams are crushed. Here’s how to navigate home loans when you or your spouse has bad credit.
Understanding How Credit Affects Your Mortgage
Credit scores play a pivotal role in mortgage applications for couples. This is because lenders will use the lower score of the two when determining the interest rate on your loan application.
A poor credit score can lead to higher rates, loan denial, or a smaller loan amount. A high interest rate could cost you tens of thousands of dollars over the course of a loan.
For example, let’s say you have an excellent credit score and decide to apply for a mortgage loan of $250,000. Your rate for a 30-year mortgage comes out to 5%. If you take the full 30 years to repay, your total expenditure over the loan’s lifespan would be $483,138.
Now instead, imagine you and your spouse jointly apply. Your spouse has a poor credit score, resulting in a higher interest rate of 5.5%. In this case, the total cost over the 30-year period would amount to $515,204. This increases the amount you pay over the 30-year term by $32,066 compared to the solo application.
Even a seemingly modest change in the loan’s annual percentage rate (APR) will result in a considerable financial difference over the life of the loan for both you and your partner.
Consider you debt-to-income ratio
However, your credit score isn’t the only factor affecting your mortgage. Your debt-to-income (DTI) ratio affects your rate and how much home you can afford. The better your DTI ratio, the more you can afford to pay each month—which means you will qualify for a larger loan.
Though a low credit score can significantly affect you and your partner’s rate, you may need more income on the loan to qualify for more expensive houses.
How to Get the Best Interest Rate When Spouse Has Bad Credit
Only Have One Person Apply
The quickest way to improve your mortgage rate when you or your spouse has bad credit is to only have the good credit borrower apply.
If the higher-income borrower on a joint loan has good credit, that’s usually sufficient to qualify for the mortgage itself. The higher-income person is always regarded as the primary borrower.
Having two borrowers on a mortgage application can help you qualify for a bigger loan since you can combine your earnings in figuring out your debt-to-income ratio. But if one of them has bad credit, that might not be in your best interest when considering the full cost of the loan.
If the good credit partner/spouse has enough income, you might consider applying under just their name. You might not be able to borrow as much and may have to limit your choices of homes, but this is the most straightforward approach.
If you decide to apply for the loan under one person’s name, you can usually still have the deed to the property under both names — the deed and mortgage are separate. However, the lender will have some say in this, so check with their policy first.
Also, if only one of you is going to be named on the mortgage, but both will be contributing toward the cost, it’s a good idea to have an agreement in place for the disposition of the home in case there’s a split — particularly for unmarried couples.
Get a Co-Signer
If you need more income to qualify for your desired loan, you might consider bringing in a different co-signer. A parent or other close relative, for example. Their good credit can stand in for the bad credit of your spouse or partner while boosting your combined income.
A few words of warning, however. First, if your new co-signer earns a higher income than you do, the lender will want to list them as the primary borrower — which your new co-signer may be unwilling to do.
Second, your new co-signer has to be willing to tie up a big chunk of their credit in backing your loan because they’ll be held responsible if the loan defaults.
Finally, the co-signer needs to be sure that you and your partner can be held accountable for keeping up with the payments. If the co-signer is worried that the bad credit partner/spouse will default on their payments, they may not be willing to co-sign.
Improving Your Spouse’s Credit Score
Improving the low credit score is a surefire way to get a better deal on your mortgage. As long as you’re not in a rush to get you and your spouse’s dream home, there are several steps you can take to improve your credit score over the course of several months:
- Pay down your credit card balance, especially if it’s close to your credit limit
- Maintain a revolving credit utilization under 30% — or 10%, if possible
- Close all but one credit card
- Review your credit report for inaccuracies and discrepancies
Though the last option won’t help you secure a mortgage in the short-term, it’s the best way to get the best possible deal while keeping both you and your spouse’s name on the mortgage.
Take Advantage of Government-Backed Loans
Government-backed loans are another option that can come in handy for low-credit borrowers. The two most common government-backed home loans are the Federal Housing Administration (FHA) program and the Department of Veterans Affairs (VA) programs.
You have to qualify for these loans, but they offer more flexibility in their credit score requirements than conventional loans.
The FHA loan program officially allows credit scores as low as 500 if you can make a 10% down payment on a home. With a credit score of 580 and higher, you only have to pay a 3.5% down payment. Keep in mind that FHA loans only allow co-signers who are related to you, and individual lenders may require you to have a higher credit score.
The VA loan program is exclusive to Veterans and Service Members, so you can only qualify if you’re a Veteran, active-duty service member, or an eligible surviving spouse. The Department of Veterans Affairs doesn’t set a minimum credit score requirement, but most lenders will require a score of at least 620 — and as long as you qualify, you don’t have to make a down payment.