Buying a house is possible with bad credit, but it is harder and more expensive than it is for those with excellent credit. Bad credit can be a result of circumstance or not knowing better. A home is one of the biggest purchases most people will make in their lifetime, and it can be a stressful process, even if you have great finances.
There are private and government-backed loan options that make it possible to become a homeowner even if you have bad credit. Other options include raising your credit score before you begin looking for mortgages. Having a higher credit score makes it easier to get a loan and helps you receive the best rates.
While it may take some work to improve your finances and get your credit rating up, it is certainly within reach. Let’s look at the options.
What Do Mortgage Lenders Consider A Bad Credit Score?
Most borrowers do not know this, but many lenders do not require a specific minimum credit score to buy a house. A conventional mortgage lender is free to set their own requirements when it comes to your credit score. Government-backed loans give mortgage lenders some peace of mind but they do have credit score requirements.
If you have a credit score lower than 500, you might find getting a mortgage a bit hard and will probably need to focus on increasing your score first. The minimum credit score you will need depends on the loan type. Another option that prospective homeowners with bad credit can take is purchasing a home with a co-borrower.
First, let’s take a look at the credit score ranges from FICO:
Exceptional credit = 800 and above
Very good credit = 740 to 800
Good credit =670 to 740
Fair credit = 580 to 670
Poor credit = under 580
How Your Credit Impacts Your Purchasing Power
If you have poor credit rating, it typically means that you will have a difficult time getting approved for loans. The good news is, it is relatively easy to raise your credit score—it just takes some time and due diligence.
One of the biggest things lenders will look at is your payment history. If you have a history of irregular or missed payments, lenders will be more hesitant to approve a loan. It is important to pay credit card bills and other loans on time, and if possible, at higher amounts than the minimum payment due. This will show a lender that you have the capability to pay off debt and manage credit.
Another key area of concern for lenders is your debt-to-income ratio. Debt-to-income ratio, or simply DTI, refers to the percentage of your monthly income that goes toward debt payments. When applying for a mortgage, you will authorize a credit check where lenders examine your credit history, including your current debts and the minimum monthly payments for these debts. They will calculate your total monthly debt payments, and then divide this by your gross income to determine your DTI ratio. So, if you have a gross monthly income of $5,000, and $500 in monthly debt payments, you have a DTI ratio of 10%—which is excellent. But mortgage lenders do not only look at your current debts when calculating DTI ratio. They also factor in “future” mortgage payments to gauge affordability.
Lenders will use this information to determine your ability to manage your monthly payments and repay what you’ve borrowed. If possible, aim to reduce your overall debt—this will help improve your debt-to-income ratio and make it easier for you to get approved for a mortgage.
One thing to keep in mind is that it is wise to keep your credit card balances below 50 percent of your limit. This will show you can manage debt and thus, keep your credit in good standing.
Can You Buy A House With Bad Credit?
Government-backed loans typically have lower credit score requirements, but homebuyers with less-than-ideal credit can still get a private mortgage if they make up for it in some other way. You may be able to put more toward your down payment, which reduces the size of the mortgage you need — and the lender’s risk. This costs more upfront, but you start with more equity in your home. This can be a better financial move than putting down less upfront and paying more in interest.
While it is possible to qualify for a conventional mortgage with a low credit score, government-backed mortgages may be a better option. Ideally, if you are able to reduce your total debt now and increase your income, this will improve your debt-to-income ratio. Having a healthy level of income and few debts shows lenders you are likely to have enough cash to make your monthly mortgage payments.
No two situations are the same, and outside of your actual score, lenders will also be looking at things like:
- How much the borrower has available for a down payment
- The borrower’s overall amount of debt
- How much income the borrower earns
- If the borrower has any debts in collections
How To Buy A House With Bad Credit
If you purchase a home with bad credit, you can always repair your credit and refinance your mortgage for much better loan terms later on.
Let’s check out some of the loan options available and the average credit score requirements for each of them.
Conventional Loans: 620 minimum credit score
Conventional loans are the generic name for mortgages backed by the government’s largest mortgage agency, the Federal Housing Finance Agency (FHFA). The FHFA backs 81 percent of all U.S. mortgages, so your mortgage will probably be backed by the FHFA, too.
There is not a set minimum requirement for income, credit score or down payment to qualify for a conventional loan. However, the minimum credit score required to qualify for a conventional mortgage loan is usually a 620 or better.
USDA Loans: 620 minimum credit score
The USDA loan is a no-down-payment mortgage for buyers in rural parts of the country and lower-density suburbs. The U.S. Department of Agriculture subsidizes the program. It requires home buyers to have a minimum credit score of 620 at the time of purchase, along with other income requirements specific to a USDA loan.
VA Loans: 580 minimum credit score
The U.S. Department of Veterans Affairs guarantees VA loans for service members, veterans and some surviving spouses. VA loans are available to:
- Veterans who meet service length requirements
- Service members on active duty who have served a minimum period
- Certain reservists and National Guard members
- Certain surviving spouses of deceased veterans
If you believe you qualify, you should contact the VA to receive a Certificate of Eligibility. Some lenders may be able to get the certificate on your behalf.
Homebuyer Assistance Programs: 580 minimum credit score
Homebuyer assistance programs rarely enforce credit score minimums. Instead, they adopt the standards of their accompanying mortgage.
For example, if you are a home buyer who uses a conventional mortgage with a 620 credit score requirement, the homebuyer assistance program you use for a down payment will also use the 620 minimum.
FHA Loans: 500 minimum credit score
FHA loans let you put down as little as 3.5% if you have a credit score of 580 or higher. However, you may still be able to get a loan with a credit score of at least 500 — but you will likely need to make a 10% down payment. FHA loans also require you to pay a mortgage insurance premium.
Additionally, you must meet the following requirements:
- DTI ratio of 43% or less
- Steady employment and income (proved with documentation)
- Home must be your primary residence
- The minimum credit score needed to get an FHA loan is 500.
Rent To Own Home Ownership Programs
Another option that is gaining in popularity is the rise of rent to own home ownership programs. There are companies and investors that will purchase a property for you and lease it to you with an option to purchase it from them at a later date. This is a great alternative to traditional mortgage programs if you are having trouble getting approved. This program allows you to purchase a home if you are facing credit and down payment hurdles.
You will not own the home in the beginning. Rather, you will start off as a tenant but you will work your way towards being able to secure the deed of that home with your own financing. The terms are usually set by the owner or investor of the property and do not require perfect credit or a down payment upfront to enter this agreement.
Owner-Financed Programs
Much like rent to own homes, owner financed homes are a direct agreement between you and the owner of a property that allows you to make payments that go towards the purchase of your home. The eligibility requirements, credit standards, and down payment of these types of home-ownership programs will vary from owner to owner.
Improve Your Credit Score
Taking a few steps to improve your credit score before home shopping will improve your homebuying experience exponentially. Getting a mortgage with bad credit is possible, but raising your credit score helps you access larger mortgage loans with lower rates. You will have more overall options if you raise your credit score before you buy a home.
If you have a mortgage already and do not plan on moving, boosting your credit score can help you save money on interest payments and refinance if rates drop.
Here are some tactics for raising your score and positioning yourself for better homebuying opportunities.
- Check your report and score every year
- Dispute errors
- Make your payments on time
- Only use credit cards for essentials
- Do not close unused accounts
- Temporarily avoid new credit
- Get a co-signer
Why You Should Improve Your Credit Score Before Buying
Even improving your credit score by just a few points before buying can still save you thousands of dollars. If boosting your score allows you to be approved for a conventional mortgage instead of an FHA loan, you will save the up-front mortgage insurance premium of 1.75% of the loan amount. Additionally, conventional loans tend to have lower closing costs and interest rates than FHA loans.
While both FHA loans and conventional loans will require monthly mortgage insurance if you put down less than 20%, an FHA loan includes monthly mortgage insurance for the life of the loan that you can only get rid of by refinancing—and paying closing costs on a new loan. For a conventional mortgage, the private mortgage insurance drops off once your loan balance is equal to 80% of the property value.
Find the Right Agent
Buying your house should be a fun and fulfilling experience. If you have done your research and evaluated what you can afford and what you truly need, finding a new home can be exciting. Learning more about the purchase process eliminates the fear of the unknown and lets you search for a home with peace of mind.
Windermere’s community of real estate professionals is our greatest asset. We have experts in all areas of real estate, from your typical starter home to condos, luxury properties, and new construction. While residential real estate is the mainstay of our business, Windermere also has offices and associates who specialize in property management, commercial real estate, and relocation services. To further facilitate the home buying process, Windermere has affiliated partners in certain regions to provide mortgage, title, and escrow services.
Call us today with any questions or concerns. Our professional Real Estate Agents will help you through this exciting process. (951) 369-8002