When Good Credit Marries Bad Credit

November 2, 1998, Revised November 22, 2004, July 17, 2009, Reviewed February 2, 2011

"My fiancee and I are first time buyers and would like to purchase a single family home in New Jersey. He has an outstanding credit report and I have a bad one (collections, late payments, bounced checks). We both make 60K a year and each has 20K in the bank. What are the chances of us getting a mortgage with a decent interest rate?"

Available Options When Good Credit Marries Bad Credit

Here are your options:

Option one: Buy the house together as co-owners and co-borrowers. In this situation, your bad credit will result in a bad credit rating for the transaction, and a corresponding high interest rate. This is exactly what you are looking to avoid.

Option two: Have "good-credit" buy the house alone, leaving "bad-credit" out of the deal. But then the mortgage would be limited to the amount that the income of "good-credit" can support. This means that you might not be able to purchase the house that you want and that would be affordable if both incomes were taken into account.

Option three: Have "good credit" buy the house using a "no-income verification" mortgage. Then the mortgage amount would not be limited by the income of "good-credit" because the lender will not consider income in underwriting the loan. However, qualifying for a no-income verification loan requires that you put up a large down payment – probably 25 or 30% of the property value. Note: The financial crisis eliminated this option.

Option four: Have a third party with good credit and income replace "bad-credit" as the co-borrower. Usually only a parent would be willing to play this role.

Which way you go depends in large part on how much you want to spend on your house. The table below provides estimates of the highest sale price you can afford at different down payment requirements, income, and available cash. It indicates that the no-income verification option would limit you to a house in the $120,000 to $140,000 range because of the large down payment requirement. On the other hand, the income of "good-credit" alone, along with the cash from both of you, would allow a $340,000 house at 5% down.

That looks like the way to go unless you want to spend more, in which case you must find another co-borrower.

Maximum House Price Annual Income Available Cash Down Payment (% of Price)
$450,000 $120,000 $40,000 5%
290,000 120,000 40,000 10
140,000 120,000 40,000 25
120,000 120,000 40,000 30
220,000 60,000 20,000 5
340,000 60,000 40,000 5

Note: It is assumed that the loan rate is 7%, mortgage insurance raises this to 7.79% on a 5% loan and 7.54% on a 10% loan, the mortgage payment plus taxes and insurance cannot exceed 28% of income, taxes and insurance are 1.825% of sale price annually, and settlement costs other than down payment are 4% of the loan amount.

I hope that "good-credit" has the foresight to insist on a pre-nuptial contract with "bad-credit" that spells out new ground rules for using credit after marriage.

Will the Debts of Poor Credit Affect the Loan-Carrying Capacity of Good Credit?

Only if the debts are joint. If they are in the name of the spouse with poor credit, they won't appear in the other spouse's credit report.

Can Poor Credit Be Part Owner of the House?

Many lenders will allow a spouse who is not a co-borrower to be a co-owner, provided her name appears on the mortgage.

In contrast to the note, which evidences the debt that the borrower promises to repay, the mortgage pledges the property as security for the debt. If the borrower doesn’t pay, the lender can acquire the property through foreclosure. To protect the right to foreclose, the lender will require all co-owners to sign the mortgage, whether they are co-borrowers or not.

Can Poor Credit Be Added to the Deed After the Loan is Closed?

Yes. However, most notes have a provision that allows the lender to demand repayment of the loan if the names on the deed are changed without the lender’s permission. The lender is unlikely to exercise this right so long as the loan remains in good standing. If the borrower defaults, however, this provision allows the lender to foreclose, even if both co-owners are not on the mortgage.

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