Are you in the market for a home but worry you won’t get approved? If bad credit is your primary concern, you could still be in luck. A lower credit score could mean more hurdles to jump over. Still, there are mortgage options that may work for you. Here’s a closer look at home loans worth considering and how to move forward with buying a house with bad credit.
Understanding Credit Score and Bad Credit
Your credit score is a three-digit number representing your creditworthiness or the likelihood of repaying debts on time. FICO is the most prevalent credit scoring model, as it’s used by 90 percent of lenders and creditors to make lending decisions.
FICO scores range from 300 to 850 and are based on data in your credit report. Here’s how they are categorized:
- Poor: 300 to 579
- Fair: 580 to 669
- Good: 670 to 739
- Very good: 740 to 799
- Exceptional: 800 to 850
As indicated, a higher credit score generally means you manage credit responsibly. However, a lower credit score could indicate past and current struggles with managing your financial obligations.
In case you’re wondering, here’s how FICO scores are calculated:
- Payment history (35%): It reflects whether you’ve paid past credit accounts on time. Missed payments, bankruptcy, foreclosures and other adverse events can negatively impact this part of your score. Consistent, on-time payments positively influence your score.
- Amounts owed (30%): This factor looks at the total amount of credit you’re using compared to your available credit, also known as your credit utilization rate. High balances on revolving debt (i.e., credit cards, lines of credit) can lower your score. It’s not just about your total debt load but how you manage it relative to your total credit limit.
- Length of credit history (15%): The amount of time each of your credit accounts has been open and the time since the account’s most recent activity contribute to this component of your FICO score. A longer credit history can be beneficial as it provides more data on your spending habits and repayment behavior. It includes the age of your oldest account, the age of your newest account and the average age of all your accounts.
- Credit mix (10%): It considers the blend of revolving and installment (i.e., personal loans, auto loans, student loans, mortgages) debt you currently have. A healthy credit mix can positively affect your score, indicating you can responsibly manage different forms of credit.
- New credit (10%): This component looks at the number of new accounts you have, the number of recent inquiries into your credit report and the time since you opened new accounts and had recent inquiries. Opening several new credit accounts in a short window can be seen as risky by lenders and decrease your score. That said, responsibly managing new credit can improve your score over time.
How Bad Credit Affects Your Ability to Buy a House
Bad credit isn’t always a deal-breaker when buying a home.
Is It Possible to Buy a House with Bad Credit?
If your credit score is lower, you may have to do more legwork to find the right mortgage product. It doesn’t mean you have to ditch your homeownership dreams, though. Still, you may incur steeper borrowing costs if you take out a home loan before improving your credit score.
What is the Lowest Credit Score to Buy a House?
It varies by the type of home loan you select. You could get a government-backed loan with a credit score as low as 500.
Most Common Home Loan Options for People with Bad Credit
Below are some mortgage products worth considering if you have less-than-perfect credit.
Conventional Loans for Bad Credit
Conventional loans, not insured or guaranteed by government agencies, typically have stricter credit requirements and are often reserved for borrowers with good credit. The baseline credit score for approval is usually around 620. However, some lenders might be willing to consider applicants with lower scores, depending on other compensating factors such as a larger down payment or stable income.
If you are approved with a credit score lower than the standard requirement, expect higher interest rates, which lenders charge to offset the increased risk they take on by lending to someone with a lower credit score. You might also face more stringent underwriting requirements.
Federal Housing Administration (FHA) Loans
FHA loans, insured by the Federal Housing Administration, are popular for borrowers with lower credit scores or limited cash reserves. They require a 580 credit score and a 3.5 percent down payment (or 500 with 10 percent down).
However, approval is not solely based on credit scores. Borrowers must also meet other requirements, including a steady employment history and a debt-to-income ratio within acceptable limits.
Veterans Affairs (VA) Loans
Backed by the Department of Veterans Affairs, VA loans are reserved for active duty service members, veterans and qualifying spouses. There’s no minimum credit score requirement, although some lenders set a threshold of around 620. You also won’t need a down payment.
Plus, borrowers avoid the expense of PMI, a common requirement for other low-down payment loans. VA loans also feature attractive interest rates and more lenient underwriting standards, making homeownership more attainable for those who have served.
U.S. Department of Agriculture (USDA) Loans
USDA loans are another government-backed option designed to make homeownership more accessible. They cater to homebuyers who want to purchase in designated rural areas and offer 100 percent financing with flexible credit guidelines.
Moreover, USDA loans often come with lower interest rates and mortgage insurance costs than conventional loans, further enhancing their appeal to eligible homebuyers. The goal is to support homeownership in less densely populated areas and offer a pathway to homeownership that might otherwise be out of reach.
Non-qualified Mortgage (Non-QM) Loans
Non-QM loans do not conform to Fannie Mae and Freddie Mac standards. If you go this route, you could get a higher interest rate or pay more in fees. Still, these home loans are worth considering as they come with more flexible lending guidelines.
Are There Other Programs for Those Buying a House with Bad Credit?
If you need more options to get approved for a mortgage with bad credit, check out these programs.
Fannie Mae HomeReady Program
The Fannie Mae HomeReady program is ideal for low-to-moderate-income borrowers with lower credit scores. You’ll need just 3 percent down, and contributions (i.e., grants and gifts) are allowed to help you purchase a home.
First-Time Homebuyers Programs
These programs are also an option if you haven’t owned a home within the past three years. You could get approved for a loan with a competitive rate and a smaller down payment.
Down Payment Assistance Programs
If you need a little help making the down payment on a home, a down payment assistance program could be viable. They vary by state (and sometimes locality) and come in the form of grants, tax credits and low-interest loans.
Grants
You might also qualify for homeownership grants that need not be repaid. This perk alone makes them a desirable option for eligible homebuyers.
How to Buy a House with Bad Credit
Once you’ve decided on the best path to buying a house with bad credit, here’s what to do next.
1. Assess Your Financial Situation and Credit Score
Get a copy of your credit report and score to know where you stand. Credit reports are available free of charge from the three credit bureaus – Experian, TransUnion and Experian – every week at AnnualCreditReport.com. However, you must purchase credit scores from the three credit reporting agencies directly or at myFICO.com.
2. Set a Budget and Manage Your Expectations
Next, run the numbers to determine how much of a house you can afford. Be sure to factor property taxes, homeowners insurance, maintenance and association fees (if applicable) into your calculation. Consider using a home affordability calculator if you need a helping hand.
3. Choose a Suitable Mortgage Type for You
If you haven’t yet decided on a mortgage product, refer back to the list of options above. Explore what each has to offer and speak with a loan officer to determine which could be best based on your financial situation.
4. Shop Around for Rates
Make a shortlist of at least three lenders and shop for rates. This entails getting preapproved and comparing loan offers to identify lenders offering the most attractive terms. Also, give special consideration to those with options for borrowers with bad credit.
5. Find the Right Lender
Select the lender you want to formally apply with and submit an application. Be sure to prepare the documents needed to avoid hiccups in the underwriting process. It’s equally important to be open and honest about your credit situation upfront and prepare to provide explanations for negative items in your credit report.
Other Tips for Buying a House with Bad Credit
Did you follow these steps but haven’t had luck getting approved for a mortgage? Don’t fret. Below are some additional suggestions on how to buy a house with bad credit and to help increase your approval odds.
Check Your Credit Report for Errors
Review your credit report and circle or highlight any errors or outdated information that could damage your credit score. File disputes promptly with the credit bureau(s) to have them resolved.
Try to Improve Your Credit Score
Refer back to the five components of your credit score listed above. Focus on areas where you can improve your credit rating, whether it’s getting current on past-due accounts, reducing your credit card balances or avoiding new credit.
Lower Your Debt-to-Income Ratio
Lenders assess your debt-to-income (DTI) ratio to gauge your ability to repay a mortgage. If this figure is high, you may be overextended, and the lender may determine you are not a good fit for a home loan. But you can lower it by paying down outstanding revolving debt balances, which reduces the minimum monthly payment.
Save for a Larger Down Payment
A higher down payment could also earn you a favorable nod from a lender. It minimizes the amount you have to borrow, which means the mortgage provider assumes less risk.
Strive for a Stable Income
A stable and reliable income is vital when purchasing a house with bad credit. This reassures lenders that you have the consistent cash flow to keep up with mortgage payments.
Apply with a Co-signer
If possible, apply for a mortgage with a co-signer with good or excellent credit and a consistent, verifiable source of income. A co-signer with financial stability can help compensate for your bad credit. Remember that the co-signer will be financially liable if you fall behind on the loan payments.
Avoid Common Mistakes
Be vigilant in your home-buying process to avoid common pitfalls. This includes taking on new debt before your loan closes or changing jobs, as both can plummet your approval odds.
Conclusion: Final Thoughts on Buying a House with Bad Credit
A lower credit score could mean fewer mortgage options, but you’re not entirely out of luck. A strategic approach could put you on the path to homeownership sooner rather than later.
Be sure to do your research to understand what loan options are available to you, along with the lending criteria you must meet to qualify. It’s also worth saving up for a larger down payment or applying for down payment assistance to minimize the loan amount.
Most importantly, work towards rebuilding your credit health by paying your bills on time, paying down your best balances and steering clear of new credit accounts. These strategies, coupled with persistence and patience, can help you achieve your homeownership goals.
FAQs About How to Buy a House with Bad Credit
Yes, securing a mortgage with a 500 credit score is possible. Your options will likely be limited to an FHA loan, and you’ll need a 10 percent down payment. Be mindful that additional conditions may apply, and interest rates could be less favorable due to the elevated risk you pose to the lender. Interest rates also vary by lender, so it’s worth shopping around and comparing your options to find the best deal.
If your credit score is between 400 and 500, try applying for a mortgage with a co-signer with excellent credit. You should also focus on improving your credit for applying for a home loan, even if you can bring a co-signer on board.
