A bad credit score can seem like an impossible barrier to break through if you want to take out real estate loans. Luckily, many lenders understand that borrowers can improve their credit scores by taking out a loan. Take a look at the following loan options and what it takes to qualify. Everyone deserves a shot at their dream house, and despite past mistakes or slip-ups, you still may be able to get yours.
What is “bad credit” anyway?
Your credit score lies somewhere in the 300-850 range. Obviously, 300 is abysmal and 850 deserves a standing ovation. But when does a credit score switch from “bad” to “good?”
Let’s look at the different ranges for credit scores:
- Lenders consider credit scores within the 300-579 range to be “very poor” or “bad.” If your credit score is 500, however, you may still be able to get a real estate loan.
- Borrowers have higher chances of getting a loan within the 580-669 range, but that is still “fair” and not yet considered good credit.
- Once your credit score hits the 670-739 range, you can say that it’s “good.”
- Credit scores are considered to be “very good” once they reach above 740.
Don’t feel ashamed if you currently have a “bad” credit score. One in five Americans have a credit score under 600; the average score throughout the country is 675. Credit scores may change month to month, so if you have a credit score of 600 in January, you may still be able to apply for a prime mortgage by July.
A “bad” credit score doesn’t mean that you are “bad” with your finances. Simple mistakes, errors outside of your control, or minimal experience can all contribute to a low credit score. The following factors will affect your score:
- Credit history
- Dates when you opened your most recent account
- Current real estate account information
- Debts against you
- Ability to pay utilities and other bills on time
- Ability to pay off loans
- Ability to pay off credit cards and other lines of credit
Again, if you have a credit score as low as 500, you can still get a loan.
Best Loans For People With Bad Credit
Federal Housing Authority (FHA) Loans
Your best bet is to look for an FHA loan that is designed for your specific credit score. Buyers with a credit score as low as 580 can get an FHA loan that only requires a 3.5% down payment. (If you are looking to buy an $100,000 house, you will only need to pay $3,500 up front.)
If your credit score is between 500-580, you can get an FHA loan, but it comes with a price. Buyers will have to put up a 10% down payment.
Of course, the more you can put down, the better. If you can put down 20% for the down payment, you may be able to get an FHA loan with more favorable loan terms.
Veterans Affairs (VA) Loans
The U.S. Department of Veterans Affairs backs private loans for veterans, service members, and their spouses. Qualifying veterans do not have to meet a minimum credit score requirement and they can use the loan without a down payment.
In addition to these low qualifications, borrowers will not have to pay private mortgage insurance (PMI) on their loans. Private mortgage insurance allows lenders to feel more safe about the loan if the borrower can’t make payments, but it ends up costing borrowers more money in the long run. Try to avoid PMI if you can.
U.S. Department of Agriculture (USDA) Loans
If you do not have money for a down payment and are not a veteran, you still have options for 100% financing. The USDA offers Rural Development Loans for people who are considering buying real estate in rural areas. Don’t let “rural” turn you off - most likely, the location where you want to buy will still qualify. However, since USDA loans require no down payment, they do require a credit score over 640.
Not all loans cover an entire property. If you just need a few grand for renovations, you may still be able to take out a smaller amount of money with bad credit. A “personal loan” can go toward home improvement, household expenses, or to pay off debt and increase your credit score. (Personal loans cannot go toward a down payment, unfortunately.)
Consider using Peerform, a peer-to-peer lender that allows you to borrow against other borrowers. Borrowers can take out up to $25,000 through Peerform. If your credit score is above 600, you’re in luck - you can apply online and get a fixed rate quickly. However, if your score is below 600, you’ll have to search for another option.
Avant is another option if you are looking for a smaller amount of money for renovations or a down payment. Borrowers may take up to $35,000 through Avant, even with a credit score as low as 580. (The platform prefers borrowers with credit scores in the 600-700 range, but so does any lender, really.) Rates vary for Avant loans, and borrowers will not face a change in their credit score by asking for an Avant rate.
Options for Real Estate Investors With Bad Credit
Maybe you already have real estate under your belt. As an investor, you may want to take out a loan to purchase a new property or renovate the one you currently own. Renovations can increase value and help you prepare your house to be a rental property that supplements your income.
Investors often recommend borrowing against your current home as an alternative to a second mortgage. Are you still able to do this with bad credit?
Yes! If you want to borrow against your house, you have some options.
Home Equity Loans and HELOC
If you have a credit score of 620, you may be able to apply for a home equity loan or a home equity line of credit (HELOC.) These options allow you to borrow against your house up to a certain percentage of your home equity.
Home equity loans give borrowers a one-time lump sum based on the equity in your house. Borrowers can use that money toward any purchase and will start paying off the principal and interest immediately.
HELOCs work like a credit card. You can make multiple purchases throughout a draw period (which usually lasts 5 to 10 years.) During this time, you only make interest payments. Once the draw period is over, you start paying off the principal and any interest that builds up.
Did the credit score requirements for home equity loans or a HELOC turn you off? We understand. A cash-out refinance is an alternative solution that approves borrowers with a credit score as low as 550.
When you refinance, you essentially swap your current mortgage loan for a new one. Your new loan may come with different terms, including a lower interest rate or fixed interest rate (as opposed to adjustable rate.) Often, this exchange requires you to extend the loan terms and extend the overall life of the loan.
If you choose a cash-out refinance, you will get a lump sum of cash that you borrow against your house. You can use this lump sum to pay off current debts (which will increase your credit score)
A quick note about refinancing: Borrowers can refinance at any time whether they want the cash or not. If interest rates are much lower now than when you bought your home, you can apply for a regular refinance and lower your monthly payments.
The FHA offers a streamlined refinancing program that does not require a minimum credit score to qualify. This strategy can help you pay off your mortgage on time and improve your existing credit score, widening your options for a second mortgage or a real estate loan.
What To Consider Before Taking Out a Loan
When you have a bad credit score, you may feel like you are walking on thin ice. Take some extra time to sit down and think through each loan option and how this might affect your future credit scores.
Loan Terms and Private Mortgage Insurance
Borrowers with low credit scores are considered a higher risk for investors. To make up for that risk, lenders will often set loan terms that cost you more in the long run or insure your loan in case you default.
We already briefly talked about private mortgage insurance. Borrowers should also watch out for adjustable interest rates that may change over time. Interest rates determine how much your monthly payment will be and how much money you have to pay in addition to your principal (the amount you originally took out.)
Adjustable interest rates aren’t bad, but fixed rates give you more peace of mind and help borrowers predict how much money they will have to pay over the course of their loan.
How Shopping Affects Your Credit Score
Borrowers should shop around for the rates and loan terms that work best for them, but don’t drag out this process too long. Shopping for rates will affect your credit score. A single inquiry will slightly decrease your score. If you keep your shopping to a 45-day period, you will only have to deal with the consequences of a “single inquiry.” This process, when completed in a timely manner, is worth the slight dip in your score. It is more important to find the most affordable loan than to preserve every point.
Risks of Defaulting
If you have a bad credit score to begin with, you don’t have a lot of wiggle room for missing payments. Talk to a financial advisor about your risk of defaulting and what could happen if you start to miss payments.
This is especially important to consider if you are taking out a second mortgage. Cash-out refis, home equity loans, and HELOCs borrow against your house. If you default, you could lose your house and your credit score will plummet further. The lower your credit score, the fewer options you have for getting a real estate loan (or any type of loan.)
Why Your Credit Is Bad in the First Place
There are two reasons you should go back and look at your credit score before applying for a loan: your score may be an indication that you should wait to buy and you may still be able to fix your score.
Let’s talk about fixing your credit score. (Who wouldn’t want to, anyway?) Borrowers may be able to improve their credit score just by settling small debts or opening a new line of credit. If you are having trouble making payments on your current loan, refinancing may be the best strategy for you.
If you have the ability to wait a few months and use that time to pay off debts and open accounts that will improve your credit score, you might want to take that route instead.
If your credit score is the result of errors (everyone makes mistakes,) you can clear those errors up and see your score jump within a few weeks. This opens up the possibility to take out loans with more favorable terms.
Credit scores may also be the result of failing to pay back loans on time. An additional loan is not going to fix that problem if you fall into old habits. If you pay back your loans on time, sure, you can improve your credit score. But if you do not budget carefully or consider the costs of an adjustable rate mortgage, you might be harming yourself more than helping yourself.
What is your next move?
You might be surprised to see so many options that cater to a bad credit score. People with bad credit still have options for getting a mortgage and buying the home of their dreams. With careful planning, timely shopping, and the right loan, you will be on your way to happy home ownership (and a better financial situation overall!)