15-year vs. 30-year mortgage: Is one better for people with bad credit?

By Gina Pogol
Mortgage Credit Problems Columnist

Dear Gina, I filed bankruptcy several years ago and have a bad credit score, mostly because I have not opened new accounts since my Chapter 7 discharge. I have worked for the same company for years and have a very good income. The problem is my credit. Would I have a better chance of getting approved for a mortgage if I choose a 15-year mortgage instead of a 30-year loan? - Matt, Tempe, Ariz.

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Hello Matt,

Yes. If you have the income to support the higher payment required by a 15-year mortgage, applying for one can increase your chances of getting approved. Lenders know that the risk of default is lower on a 15-year loan because you accumulate home equity much more quickly, and that translates into less risk of being underwater. An added benefit to you is that 15-year mortgage interest rates are typically about 0.5 percent lower than 30-year mortgage rates.

Most automated underwriting software (AUS) factors in the lower risk of a 15-year mortgage when generating an underwriting decision. So if you get declined for a 30-year loan and you can afford the higher 15-year payments, by all means try applying for a 15-year mortgage. It only takes a few minutes to get an answer.

Because of your credit history, I assume that you will be applying for an FHA mortgage. FHA underwriting guidelines do have minimum credit scores now (500 to get a loan with at least 10 percent down and 580 to get one with 3.5 percent down), but they do not require that you reestablish credit to be considered for a mortgage. In fact, they specifically state that choosing not to open new credit accounts following a bankruptcy should not be held against loan applicants because that may be the most responsible choice.

In addition to choosing a 15-year loan, there are other things you can do to increase your chance of being approved:

  • Put more money down. Bring at least 10 percent down if you can manage it.
  • Set aside enough cash reserves. Have at least enough in the bank to cover three months of housing expenses after you close on your new home loan.
  • Establish a track record of payment. Demonstrate the ability to save money by making regular contributions to savings accounts. This has two benefits: You increase your savings, and FHA considers regular contributions to an account the same as it would count a regular debt payment. In other words, you can use that pattern to establish a satisfactory payment history.
  • Pay your rent on time. Have 12 months of perfect payment history with your landlord.
  • Continue to be careful with debt. Conservative use of credit is another compensating factor, and you have done that.

Bad credit doesn't have to keep you from getting a mortgage and buying a home, as long as you can demonstrate that you can afford the home and that you have learned how to manage debt wisely.

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