How to Buy a House With Bad Credit

Buying a house can be an exciting yet confusing process. It can also be frustrating when you’re trying to buy a house with bad credit and don’t know where to turn for answers. Many people rent with the dream of going through the home buying process and becoming a first-time homebuyer. But if you have bad credit, you may think homeownership is out of reach.

Can you buy a house with bad credit?

The answer is yes. But what does a bad credit score mean, and what are the types of home loans available to those with bad credit? We’ll answer those questions and detail the necessary steps you need to take to buy a home with poor credit.

What do lenders consider bad credit?

Mortgage lenders and the Federal Housing Administration (FHA) look at a credit score range when considering a home mortgage loan. A credit score between 580-669 ranks your credit as “fair” and is regarded as a higher risk for a mortgage lender. Lenders view a score of 579 or less to be “bad credit.” Scores this low can make finding a home loan challenging but not impossible. 

Your credit score tells a lender about your spending habits, payment reliability, and the likelihood of mortgage repayment. Low credit scores mean you’re a higher risk for a lender but do not have to mean your dream of owning a home has to come to an end.

How to buy a house with bad credit 

First, find out your credit score by getting a credit report. There are sites where you can get a free credit report, like FreeCreditReport.com. They provide credit reports from the three credit bureaus (Equifax, Experian, and TransUnion) at no charge.

Depending on your credit score, you may have some work to do, and it may take time to get the credit score needed to buy a house. 

How to improve your credit score

Focus on these financial habits to help boost your credit score if it’s lower than 580:

Improve your payment history: Payment regularity is a crucial factor used to determine your credit score. With a plan for regular on-time payments on your debts, you will improve your credit history and score with every payment. 

Pay down your overall debt to increase your debt-to-income ratio: Your available credit is also significant in your credit score. If you are maxed out and have no credit, improving your score will be a challenge. Focus on paying down debt to give yourself a credit cushion, and your score will rise. 

Decrease your credit utilization: Paying down credit cards and other personal loans will lower your credit utilization ratio, which is the sum of all your balances divided by your credit cards’ limits. Doing this also has a positive impact on your debt to income ratio (DTI). Paying down balances to under 30% will result in a significant credit score improvement.

Check your credit report and dispute any errors: For assistance, consider a credit repair service to help get you on track for buying a home. Once you get your free credit report, you may notice some errors bringing your credit score down. Significant blemishes like foreclosures, repossessions, or collections accounts can have a sizable effect on your credit report. A credit repair service will help get those errors fixed so your credit score can start moving in the right direction and help you get a better rate on a home loan.

Remove yourself from any co-borrowing accounts: If you have been a co-borrower or authorized user of an account that is currently maxed out or in default, your credit score can be negatively affected. Removing yourself from such an account can provide a quick boost to your credit score.

How much more will a low credit score cost you?

Since your credit score represents the level of risk involved when lending you money, a lower score will make it more expensive to buy a house because of higher interest rates. Borrowers that have higher scores are considered lower risk and get lower interest rates. 

Lenders consider several other factors, including the loan-to-value ratio (LTV) and DTI. Credit scores also have importance. If, for example, you borrow $300,000 and have excellent credit, you could secure an interest rate of about 4.8% or about $1,574 per monthly payment. A bad credit score could mean an interest rate of 6.4%, or $1,877 per month. Over the course of 30 years, this adds up to tens of thousands of dollars in additional monthly mortgage payments. In addition to higher interest rates, buyers with lower credit scores usually have to make a higher down payment, though down payment assistance programs can help ease the burden.

How to improve your chances of getting approved for a mortgage even with bad credit

Get pre-approved for a mortgage

One of the first items on your to-do list should be getting a mortgage pre-approval. Pre-approvals show the amount a lender is willing to let you borrow and the interest rate attached to that loan. This gives you a clear picture of what you can afford, which allows you to move quickly when making an offer for a house. Pre-approvals do not guarantee that your mortgage application will be approved, but it does give you a degree of certainty as long as your financial situation remains the same.

Increase your deposit

Lenders hesitate to loan money to people with low credit scores because they are perceived as high-risk. The easiest way to combat this is to increase the size of the downpayment. Paying more money upfront decreases your LTV ratio, which in turn will make more mortgage deals available.

Avoid applying for new credit

New credit applications will indicate to lenders that you are stretching yourself financially. Any new financing agreements or loans could serve as red flags for lenders and count against you when applying for a mortgage.

Make sure all your income can be verified

Lenders will always want to verify your income when you apply for a loan. This can be difficult to do if you do not have complete and up-to-date records. To help lenders verify your income, be sure to provide payslips and bank statements from up to the previous 12 months.

Make sure you’re registered to vote

Electoral roll data is a crucial tool for lenders to verify the identity and residence of a potential borrower. While you can have an excellent credit score without being registered, it may prove difficult to be approved for a mortgage. You can check your credit file to verify that you are in fact registered to vote.

Good loan programs for buyers with bad credit

You don’t need to take out a conventional loan to buy a house. The FHA loan insurance program helps applicants with bad credit buy a house. However, not every lender offers FHA loans, so be sure to shop around.

FHA-backed loans help you:

• Qualify for low down payments, possibly as low as 3.5%.
• Avoid the requirement to verify two years of employment.

The downside? You will likely pay a higher interest rate on your home loan.

When your credit score is above 580, you could qualify for a mortgage with as little as 3.5% down and allowed an LTV of 96.5%. Lenders use a loan-to-value ratio to compare the size of the loan you’re taking out to the value of the property you want to purchase. 

For example, you could buy a home in Sacramento, CA, for $200,000 with an LTV ratio of 96.5%, meaning you couldn’t borrow more than $193,000, making $7,000 (or 3.5% of the home’s purchase price) your minimum down payment. With a score of less than 580, you’ll need a larger down payment of at least 10%, and your LTV will be no higher than 90%. 

VA Loans

Military veterans with a minimum credit score of 620 have access to Veteran’s Administration (VA) loans. If you can boost your credit score to qualify, additional VA loan benefits include: 

• No down payment
• No private mortgage insurance (PMI)
• Lower interest rates 

USDA loans

United States Department of Agriculture (USDA) loans are available for homebuyers who are lower-income and considering buying in rural areas. The minimum credit score required to take out a USDA loan is 620, but there are additional program benefits, including: 

• No down payment
• No private mortgage insurance (PMI)
• Lower interest rates 

Freddie Mac Home Possible loans

Home Possible loans make it easier for first-time buyers to get homes. Home Possible is available to borrowers with low or moderate-income. In order to qualify for a loan with reduced private mortgage insurance (PMI) rates, borrowers must have a credit score of 660. Benefits include:

• 3% down payment
• Down payment assistance programs for borrowers who need additional help

Fannie Mae HomeReady loans

HomeReady loans were released in 2015 and intended for low to moderate-income borrowers. They provide expanded eligibility for home loans in low-income communities. HomeReady requires a credit score minimum of 620 to qualify. Unlike the Freddie Mac Home Possible program, you do not have to be a first-time homeowner to qualify. Benefits include:

• 3% down payment
• Ability to use additional income from roommates to qualify for the loan

Non-qualified (non-QM) mortgage

The qualified mortgage rule, or the QM rule, went into effect in 2014 with the goal of creating saver loans by limiting or prohibiting certain mortgage products that were considered high-risk. This rule helps explain why most conventional loans have credit score minimums in the 600s. While these loans tend to have higher interest rates, they are much more accessible for borrowers with low credit scores. It’s possible to get a non-QM with credit scores as low as 500, though you’re much more likely to be approved if your score is at least 580, which is also the minimum score to qualify for FHA loans.

Take steps now to improve your credit score and move closer to your dream of homeownership. You could qualify today for an FHA, USDA, or VA loan, depending on your circumstances. 

Do your homework to find mortgage lenders who will work with you to apply and qualify for these financing options so you can buy a house even if you have bad credit.

Should I improve my credit score before buying a house?

This is totally up to you. In the long run, increasing your credit score will save you a lot of money when buying a home. With that being said, the housing market is always fluctuating and real estate tends to appreciate in value over time. This can help offset the cost of borrowing with bad credit. However, if you’re unable to meet the minimum credit score requirements to get approved for a mortgage application, you will have to prioritize raising your credit score.

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