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Buying a home is the American dream for many couples, but unless you're able to pay in cash, you'll likely have to take out a mortgage. If your spouse has bad credit, you might still be able to buy a house, but it might take some extra work and considerations in order to qualify for the mortgage loan. Here are some things to consider before you start browsing Zillow.
Joint vs. Single Applicant: Decide How to Apply
When you're applying for a mortgage with a significant other, you have the option to apply either individually as a single applicant or together as joint applicants. Why would you want to leave your spouse off the application? Lenders don't just average out your two credit scores or go with the highest one when evaluating your creditworthiness as a pair—they pay the most attention to the lowest credit score. If your credit is great but your spouse's isn't so hot, a joint mortgage application could be denied.
Lenders also look at your debt-to-income ratio (DTI), which compares the total amount you owe each month with how much you earn, when determining your eligibility for a mortgage. If your spouse has a significant amount of debt as compared with income and they're applying for the mortgage along with you, it might be denied. Even if your joint mortgage application is approved, your loved one's poor credit or high DTI could land you with a higher interest rate than if you'd applied alone. With a loan as large and as long as a mortgage, a higher interest rate can cost you tens of thousands of dollars or more over the life of the loan.
Here's an example of how much of an impact your annual percentage rate (APR) can make. Say you're taking out a mortgage loan for $175,000. You have great credit so you apply by yourself, and you score an interest rate on a 30-year mortgage of 4%. If you take the full 30 years to pay it off, you'll spend $300,773 over the life of the loan. Now let's say you apply jointly with your spouse, who has less-than-stellar credit, and you get a higher interest rate of 4.5%. You'd pay $319,212 over the life of the loan—a difference of nearly $20,000.
However, there's another factor to consider: Your income is analyzed by lenders as a way to determine whether you can afford repayments. If you have a high income or are the primary or only breadwinner, that might not be a problem. But if not, it might be worth the risk of including your partner on the application if you need their income to qualify for the loan.
Mortgage Options if Your Spouse Has Bad Credit
If your spouse has credit problems, don't fret just yet: There are a few things you might be able to do to get a mortgage with bad credit.
Lenders weigh criteria differently. Some put more emphasis on factors besides your credit score, such as DTI. If your spouse has a low debt-to-income ratio, it may help outweigh their credit problems.
Another tactic that could reduce the impact of their bad credit is making a larger down payment, which shows the lender you won't have to borrow as much. Also, many lenders offer programs for first-time homebuyers that tend to be more lenient with credit criteria. For example, many offer FHA loans, which are part of a government program that allows down payments as low as 3.5% and permits lower credit scores than conventional mortgages.
Some lenders offer other types of first-time homebuyer mortgages, such as Fannie Mae's HomeReady Mortgage, which allows lower income and credit scores than on a typical mortgage.
Consider Improving Your Spouse's Poor Credit Before Applying
If you and your spouse are dead-set on applying for a mortgage together, you have another option if you're not in a rush: Spend some time working to improve your spouse's credit first. Here's how.
- Review their credit report. Start by getting a free credit report and making sure there aren't any errors that could be bringing down your spouse's credit scores. If there are any mistakes on the report, dispute the errors to get them removed.
- Pay all bills on time. Payment history is the most important factor in calculating credit scores, so make sure all of your bills are always paid on time. Even one missed payment can cause your scores to drop significantly.
- Lower their credit utilization ratio. Your credit utilization ratio shows lenders what percentage of your available credit you're using. If you have a ratio higher than 30%, your credit scores could drop. Keep your utilization below 30% or, ideally, below 10%.
- Add them as an authorized user. Another strategy for improving your spouse's credit is to add them as an authorized user to one or more of your credit cards. While not every credit card issuer reports authorized-user activity to the three main credit bureaus (Experian, TransUnion and Equifax), and not every score factors in authorized-user activity, some do. And if they do, when the primary account holder manages the account responsibly, the authorized user's credit can benefit from it.
If you want to pursue this option, first ask your credit card issuer if they report authorized-user activity to the credit bureaus to ensure your spouse's report would benefit from it. If so, and assuming you both make smart decisions with your card, your spouse's scores should begin to rise over time.
If your spouse's credit isn't so hot, applying for a mortgage jointly could make it harder for you to qualify. But if you need your spouse on the application to meet income requirements, there are mortgage options for bad credit—or you can spend some time working on improving their credit before you apply.