Finding home loans with bad credit isn't for the faint of heart—or at least not something you should do without some serious homework. But there's good news if you're a first-time home buyer wondering how to buy a house with bad credit: It can be done!
A good credit score typically means you'll get a great mortgage. A bad credit score means you're in trouble, but you shouldn't just throw in the towel. From low credit score mortgages to cash options to down payment strategies, this crash course explains how to buy a home with bad credit. Yes, it can be done.
What is a bad credit score?
First things first: While you may have a vague sense your credit score is bad, that's not enough. How bad is it, really?
Ideally, you should check your credit report long before meeting with a mortgage lender. Your credit score is based on the information that appears on this report, and you’re entitled to a free copy of your credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) at AnnualCreditReport.com.
Credit scores, also called FICO scores, range from 300 (awful) to 850 (perfection).
If your credit score is 750 or higher, “you’re in the top tier” and positioned for the best interest rates and the most attractive loan terms for home buying, says Todd Sheinin, mortgage lender and chief operating officer at New America Financial in Gaithersburg, MD.
A good credit score is from 700 to 749. If you fall below that range, lenders will start to question whether you’re a risky investment as a potential borrower.
“If your credit stinks, you’re at an immediate disadvantage and may have trouble qualifying for a home loan,” says Richard Redmond, a mortgage broker at All California Mortgage in Larkspur and author of “Mortgages: The Insider’s Guide.”
So, what next?
Check for errors
If your credit rating is subpar, that's no reason to beat yourself up (at least not immediately), because you may not even be to blame for all of those blemishes.
Creditors frequently make mistakes when reporting consumer slip-ups. In fact, 1 in 4 Americans finds errors on credit reports, according to a 2013 Federal Trade Commission survey. So make sure to scour your credit report for slip-ups that aren't your own. From there, you'll need to contact the organizations that provided the erroneous info (e.g., a bank or medical provider) and have them update it. Once that's done, your credit score will rise accordingly on your credit report.
As for any mistakes that are your fault? If they're one-time mistakes, it never hurts to call and ask that they get removed from your record.
The only fix for major mistakes (darn chronic credit card debt), however, is time. Banish bad credit by making payments by their due date (late payments truly are the devil for hopeful home buyers), and you will gradually see your credit score rise. Just don't expect to rewrite your credit history overnight. You have to prove to lenders that you're up to the task of making those mortgage payments on time—all while saving for a down payment, of course. Nobody said this would be easy!
Pay up for a home loan for bad credit
Depending on your credit score, you might still qualify for low credit score mortgage options—but you should expect to pay a higher interest rate, says Sheinin. Getting a mortgage with a higher rate means you’ll pay your lender more money in interest over time, of course, but it at least enables you to join the home-buying club.
With interest rates still historically low (check yours here), it could make sense to buy now and take the higher rate.
Get a low credit score home loan
A Federal Housing Administration loan is one option for prospective home buyers with poor credit, as the FHA typically offers these mortgages for less-than-perfect credit scores and first-time home buyers. The FHA requires a minimum 580 credit score (and other requirements) to qualify, but FHA loans also enable you to make a down payment as low as 3.5%.
The big drawback? Because the federal government insures these low credit score home loans, you’ll pay a mortgage insurance premium, which is currently assessed at 1.75% of the base FHA loan amount. However, depending on your actual credit score, certain conventional loans may still be available to home buyers with low credit, and these loans may require a slightly smaller down payment than the FHA loan minimum. Be sure to do your homework when exploring the FHA option.
Increase your down payment
If you have poor credit but a lot of cash saved up, some mortgage lenders might be willing to approve you for a home loan if you make a larger down payment.
“The more you put down, the more you minimize the risk to the lender,” says Sheinin.
So, by increasing your down payment to 25% or 30% on a conventional loan—instead of the standard 20%—you’ll strengthen your mortgage application, making yourself far more attractive to a lender. Just remember that your bad credit score can still negatively affect your mortgage loan's interest rate.
Still, though, the chance to own your own home may outweigh those downsides any day. So if you're convinced your credit history is sure to dash your home-buying dreams, chin up! Put in the work to overcome your bad credit—develop a healthier relationship with credit cards, work with a knowledgeable lender, and explore all of your mortgage options.
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