Guide for First-Time Homebuyers with Bad Credit

Mortgage

Shopping for your first home is an exciting time. You are choosing a place to plant yourself and bloom for many years to come.

couple buying a home

However, home shopping is not all fun and games. Not only do you have to find the perfect home, but also the right financing terms for your new mortgage. If you have bad credit, you are likely worried about your mortgage options.

As a first-time homebuyer, the process of buying a home can be overwhelming. Before you lose hope, it is entirely possible to secure a home loan with bad credit. Many mortgage lenders offer subprime home loans that work specifically with borrowers with poor credit. We will dive into the details to help you navigate the first-time home-buying waters more easily.

How Bad Credit Can Affect Your Home Loan

Typically, lenders that approve loans to borrowers with bad credit offer less than favorable terms. In most cases, you can expect to pay a higher interest rate.

A slightly higher interest rate might not seem like a big deal. However, even a slight increase in your interest rate could result in thousands of dollars in interest payments over the course of your loan.

When you sort through your loan offers, make sure to run the numbers. You might not be willing to pay the premium rates for the opportunity to buy a home right now.

Other Factors that Mortgage Lenders Consider

As a borrower, your credit score is not the only factor lenders consider. Before a mortgage lender approves a large loan, it will look at various other factors, including:

  • The amount of money in your savings account. If you have a healthy savings account, that may offset your bad credit.
  • Income. The higher your income, the more likely you are to be approved.
  • Employment history. If you just landed a high paying job, then the lender might be less willing to work with you. However, consistently earning a high income for many years will strengthen your application.
  • Debt-to-income ratio. If you already have a high debt burden, then lenders may be less willing to work with you.
  • Current expenses. If your current rent payment is similar to the mortgage payment, then a lender may see that you are able to easily handle that expense.

When you go through the home buying process, expect to provide a lot of paperwork to verify this information. In many cases, you will be required to provide tax statements, paychecks, and more. However, if you stay organized throughout the process, your sanity will thank you later.

How to Secure Home Financing with Bad Credit

To qualify for a bad credit home loan, you will need to be willing to put in the time. Finding the best option for your situation may require some patience. Not all options will work for everyone, but it is likely that at least one option will work for everyone.

See Where You Stand

Before you start looking for homes, take a closer look at your financial health.

Start by checking your credit score. A free way to do this is through Credit Karma. Once you know where your credit score is, take the time to find your credit report. Once you have your credit report, read through for any errors. A mistake on your credit report may be dragging your score down. If you find any mistakes, you can dispute them.

After digging into your credit score, take a step back. Assess your savings. Have you grown it steadily? Either way, it is crucial to understand exactly how much house you can afford.

Consider Saving for a Larger Down Payment

One way to secure a mortgage loan with more favorable terms with bad credit is to provide a larger down payment. Bigger down payments give the mortgage lender reassurance that you are able to repay the loan.

For conventional loans, banks typically require a down payment of at least 20%, but there are many options for a lower down payment. But you can usually secure better terms if you wait until you’ve saved a sizable down payment.

Find A Lender that Will Work with You

Not every lender is willing to work with bad credit borrowers. Although, you may not be able to secure a conventional loan from a well-known bank, it is entirely possible to find a lender.

If you have bad credit, you’ll need to find a lender that offers subprime home loans or that works with government-backed programs.

Luckily, many mortgage lenders are likely willing to work with you. The tricky part can be finding your choices. Check out our top mortgage lenders to get started.

Financing Options for First Time Homebuyers with Bad Credit

The federal government offers several assistance programs for buying your first home. Take a minute to find out if you qualify for any of these programs.

FHA Loans

If you have bad credit, an FHA loan might be your best option. The minimum credit score to qualify for an FHA loan is just 500! Of course, some mortgage lenders may require a slightly higher score to approve you. But you can shop around to find a lender willing to work with you.

If your credit score is between 500 and 579, the Federal Housing Administration (FHA) requires a minimum down payment of at least 10%. However, if you have a minimum credit score of 580, you’ll only be required to put down 3.5%.

With FHA loans, a mortgage insurance premium (MIP) is required along with an upfront MIP fee of 1.75% of the loan amount.

As a first-time homebuyer with bad credit, the benefits of this program can help your home purchase go smoothly.

USDA Loans

If you are willing to live in a rural community, a USDA loan could be a suitable option. These loans are guaranteed by the United States Department of Agriculture, and don’t private mortgage insurance (PMI).

Typically, you’ll need a minimum credit score of 640 to score a USDA loan. However, a lower credit score does not automatically disqualify you.

If you have a low credit score, then the lender will look more closely at other contributing factors before deciding on your loan application. You may need to prove that your credit was damaged by something outside your control or provide credit references like utility statements to prove your creditworthiness.

VA Loans

A VA home loan is guaranteed by the Department of Veteran Affairs. If you meet the requirements of service, then you could qualify for a no down payment option to secure the home of your dreams.

In contrast to traditional lenders, the VA home loan program has less strict requirements when it comes to their loans. The goal of the program is to get the bravest in our nation into a safe home. With that, lenders that provide VA-backed loans can offer loans to borrowers with lower credit scores.

Almost every member or veteran of the military, reserve, or National Guard is eligible to apply for these loans. The first step you should take is to secure your Certificate of Eligibility. With that, you’ll be able to apply for a VA loan with an approved lender.

See also: How to Get a VA Loan with Bad Credit

Research State Assistance Programs

The U.S. Department of Housing and Urban Development works to provide affordable homeownership options throughout the country. In many states, they offer first-time homebuyers assistance.

Depending on your area and income, the type of assistance may vary. For example, in some areas, you may qualify for a down payment grant that will help you secure your home purchase. With a higher down payment, you may be able to offset the negative effects of your poor credit score.

Compare Mortgage Rates

Once you have determined the best path for you, it is time to compare lenders. If you take the time to shop around for the best loan terms, you stand to save thousands of dollars over the course of your loan.

Shopping around for the right lender might be the most important part of your entire home buying process. Find a lender that you are comfortable with and that is willing to work with your poor credit score.

Work on Your Credit Score

A surefire way to secure better mortgage terms is to improve your credit score. If you can wait on your home purchase, then you might have a stronger loan application.

Improving your credit score will take time. But if you put in the effort the long-term benefits are worth it. Not only will you be more likely to be approved for loans, but also will likely pay less in interest payments.

To start improving your credit score make sure to pay bills on time and work towards paying off your debt.

First-Time Home Buyer with Bad Credit FAQs

Can I buy a house with bad credit?

Yes, it is possible to get a home loan with bad credit. However, the interest rate and other loan terms may be more expensive than if you had good credit.

You may also need to have a bigger down payment and show proof of income. However, there are also lenders who specialize in offering mortgages to people with low credit scores.

What are the requirements for getting a mortgage with bad credit?

  • Have a steady income: Lenders want to know that you have a consistent income, so they will want to see evidence of your income such as pay stubs or W2s.
  • Have enough money saved for a down payment: With poor credit, most lenders will require a down payment of at least 5-10% of the purchase price.
  • Accept higher interest rates and fees: With a weak credit history, you may be required to pay higher interest rates and fees.
  • Find a cosigner: Having a cosigner can help you get approved for a mortgage with bad credit. The cosigner will be held responsible for the loan if you are unable to make your monthly mortgage payments.

What do mortgage lenders consider a bad credit score?

Lenders generally consider a credit score below 580 to be bad credit. Lenders may also consider scores between 580 and 669 to be fair credit. Credit scores of 670 or higher are typically considered good credit.

What is the minimum credit score needed for a mortgage?

Minimum credit scores needed for a mortgage varies by lender, but typically a score of 620 or higher is required for conventional loans, and a score of 500 or higher is required for FHA loans.

The minimum credit score needed for USDA loans is typically 640, and the minimum credit score needed for VA loans is typically 620.

What type of mortgage loan is best for someone with bad credit?

The best type of loan for someone with bad credit is usually an FHA loan. These loans are typically easier to qualify for than other types of loans, as they have more lenient credit score minimums and down payment requirements.

What other factors do lenders consider when evaluating my loan application?

Lenders will typically look at your credit score and credit report to assess your creditworthiness. They may also consider your down payment, debt-to-income ratio (DTI), income, employment history, and assets when evaluating your loan application.

Your down payment can show lenders that you are committed to the loan, and can also help to reduce the amount of the loan. Your DTI ratio is a measure of how much of your income is going towards paying off your existing debts. A higher DTI ratio can indicate to lenders that you may not be able to afford a loan.

Your income, employment history, and assets provide further evidence that you are a reliable borrower, and can help to establish your ability to repay the loan.

What is a conventional loan?

A conventional loan is a type of loan that is issued by private lenders and purchased by government-sponsored enterprises such as Fannie Mae and Freddie Mac.

How can I improve my credit scores?

  • Pay your bills on time: Payment history is the most important factor in your credit score, so be sure to make payments on all your bills on time.
  • Keep credit card balances low: Your credit utilization ratio, or the amount of available credit you are using, makes up 30% of your credit score. Try to keep your credit card balances low by using no more than 30% of your credit limit.
  • Don’t open too many new accounts: Opening too many accounts in a short period of time can be a red flag for lenders and can hurt your credit score.
  • Check your credit report: Make sure to regularly check your credit report for errors or other negative information that can hurt your score.
  • Consider a credit builder loan: Credit builder loans are designed to help people with no or low credit build a payment history and improve their credit score over time.

Bottom Line

Purchasing the home of your dreams with bad credit is not impossible. You will need to put in the time to figure out which path is the right one for you.

Once you see your financial path to your home, make steps towards that goal every single day. Your new home is not as far away as you think!

Sarah Sharkey
Meet the author

Sarah Sharkey is a personal finance writer who enjoys helping people make better financial decisions. Sarah enjoys traveling, hiking and reading when she is not writing.