Bad credit shouldn’t keep you renting your whole life, and many lenders believe so, too. While you should always work to build your credit, we’ll teach you how to buy a house with bad credit in the meantime.
Why does my credit score matter when buying a home?
Your credit score is like your report card from school. Lenders look to your credit score as a benchmark to see how well you pay your debts on time, how much debt you are in, and how long you’ve been building your credit. Essentially, it’s a way for them to see how risky it is to lend you money.
Here’s the breakdown of your FICO credit score if you’re curious how your credit will measure up:
Payment History (35%)
If you want to keep your credit score high, you’ll need to watch your late payments. One 30-day late payment on your record with a 780 credit score can drop your score as much as 110 points, according to Experian.
Debt-To-Credit Utilization Ratio (30%)
This is the amount of credit card debt you have divided by the limit you’re allowed to use on your card. Most lenders like to see this ratio at 30% or below, as any higher than that and you may have difficulty paying your other bills.
Length of Credit History (15%)
The longer credit trail you leave, the better lenders can follow it. That means if you’ve had your credit card for quite a while, are up-to-date on all of your monthly payments, and don’t max out your cards, the lender will look favorably at that. If, on the other hand, you haven’t had a line of credit for very long—even if your lender sees that you’ve been paying everything on time and keeping the balances low—they’re not going to want to lend to you as readily.
Credit Mix (10%)
Mortgage lenders want to see that you have a variety of loans. This could be in the form of a credit card, a car loan, a store-specific credit card, or a mortgage. They like to see that you can keep up multiple payments simultaneously without dropping your score.
New Credit (10%)
Each time you apply for a new line of credit (just apply—not even open a new account!) a company will do what is called a hard inquiry on your credit. Each hard inquiry drops your credit score about 5 points. This may not seem like much, but it could be the difference between getting a mortgage or staying in your rental.
Now you know what makes up your credit score, you may be wondering what credit score you need to get a mortgage.
Before we dive into that, remember that getting a mortgage loan is about more than just your credit score. While that is a crucial step, you could have great credit and not get approved for a home loan. There are multiple factors at play and your best bet to see if you’re qualified for a home loan is to talk to your real estate expert.
Here’s your credit rating on the scale of good credit vs. poor credit (via Experian.com):
|Type of Credit||Credit Score|
|Very Good Credit||740-799|
|Very Poor Credit||300-579|
Loans for Bad Credit
The credit score you need depends on the type of loan you use. Here are a few loan types that you can use with poor credit.
Fannie Mae and Freddie Mac have recently lowered the bar of their loan requirements to allow those with a credit score as low as 580-620 apply for and get a mortgage. It is known as the HOPE program, and it is designed to help those with lower or distressed credit be able to get homes.
Although lower credit scores can be approved, keep in mind that a lower credit score approval usually means that you’ll need to put down a larger down payment. Also, you are more likely to have a higher interest rate and private mortgage insurance with lower credit.
Federal Housing Administration (FHA) Loans
Using an FHA loan with bad credit is usually the easiest route. The FHA guidelines state that they may accept credit score as low as 580 with a 3.5% down payment. This is great news if you need a home loan but don’t have as much money to put down for a down payment.
One caveat: Interest rates of FHA loans do increase with lower credit scores and lower down payments. The average interest rate for an FHA loan with good credit and a 3.5% down payment is 4.25% and goes up from there as your credit score goes down. Additionally, any loan with a down payment less than 20% of the purchase price of the home will have mortgage insurance added on to it.
VA loans are loans provided by the Department of Veterans Affairs for veterans and their spouses. These are some of the best loans, as they offer as little as 0% down payments and no private mortgage insurance. As with conventional loans, most lenders like to see credit scores of 620 or above, although it depends on the underwriter. VA loans are a great option for those who have bad credit and no down payment.
How to Buy a House with Bad Credit
If your credit score is needing a bit of help, here are a few things you should do before applying for a home loan.
If you want to get a home loan with bad credit, you’ll want to start early to see if you can’t make it the best it can be. Ideally, you’ll start repairing your credit two years before you plan to buy a house. If that is too far away, start immediately. It’s never too early to start repairing your credit.
Check your credit score.
Sites like Credit Karma or Credit Sesame will give you your credit score for free. The great part about these sites is it only runs a soft inquiry, meaning it won’t dock your credit score for looking at it. If you do have a lower credit score, look at the details. There may be errors you can dispute.
Dispute any errors.
If you see something on your credit history that just doesn’t look right, such as a purchase or bill that has gone to collections, contact the lender and dispute the charge. It may be that you already paid it or you are a victim of credit card fraud.
Get current on your payments.
If you are behind on any of your payments, get and stay current on them or pay them off completely if you can. Dave Ramsey has a great process for paying down debt quickly, but make sure you don’t close the accounts! Because lenders look at the length of time your account has been open and factor that into their decision, you don’t want to close an account, even if the balance is zero.
Try alternative financing.
If your credit score is still too low to get a home loan from a traditional lender, you may want to consider an alternative form of financing. This can be a loan from a family member or friend that you work with to decide the terms of the loan, the seller of the house you are buying directly, or get a co-signer to help you get a loan.
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