You want to buy a new home, but your credit score is low. Does this mean you’re out of luck? It depends.
The good news is that there are several mortgage loan programs available to you. The bad news is, without excellent credit, you will undoubtedly have to pay higher interest rates.
Some mortgage lenders will scoff or tell you to try again when your credit score is higher. But with a little legwork, buying a house with bad credit is possible. Keep reading for tips to help you get approved.
Know Your Credit Scores
How low are your credit scores? Do you know what’s causing you to have poor credit? Or are you assuming it’s bad because of past financial missteps?
What is a ‘bad’ credit score?
What constitutes a bad credit score? Generally, the ranges are as follows:
- Excellent: 781 and above
- Good: 661-780
- Fair: 601-660
- Poor: 501-600
- Bad: 500 and below
So, if your credit score is 600 or lower, you’d fall into the subprime consumer category.
Check Out Our Top Picks for 2023:
Best Mortgage Loans for Bad Credit
How Your Credit Scores are Calculated
You should also have an understanding of how your credit score is calculated so you’ll know how much to improve it before applying. The five components are as follows:
- Payment history (35%): Do you make timely payments to your creditors each month? If you’ve missed several payments in the past, your credit scores could be suffering. And other past-due bills that became collection accounts also negatively impact your payment history.
- Amounts owed (30%): How much do you still owe creditors? If your debt-to-available credit or credit utilization ratio on revolving accounts is high, it could affect your credit scores.
- Length of credit history (15%): How long have you had credit? A more established credit profile could equate to a higher FICO score.
- Credit mix (10%): Do you have a healthy mix of revolving and installment credit? Lenders like to see a combination of both, and having several of one and not the other could lower your credit scores.
- New credit (10%): Have you recently opened several new credit accounts? If so, prospective lenders may see you as more of a risk.
How to Check Your Credit Score
There are several free options to choose from. However, you can start by contacting your bank to see if it’s a service provided to account holders, free of charge. Or if you have credit cards, check the statement or online dashboard as it may appear there.
Did you recently apply for a mortgage and were denied? Lenders must explain their decisions in a letter and disclose that you can request a copy of the credit report used to make the decision.
In some instances, the denial letter will explain the denial and the credit score the lender used during the evaluation process. Lenders use different algorithms and credit scoring models. However, you can use this number as a starting point.
Rectify Errors in Your Credit Report
According to the results of a study conducted by the Federal Trade Commission (FTC), 20% of credit reports contain errors. But why does this matter? Well, what’s in your report determines your credit score. And there’s a possibility that an error could result in a low credit score and prevent you from obtaining a mortgage.
So, you’ll want to get a free copy of your report and review it from top to bottom. If you spot errors, take the following steps to have them rectified:
- Step 1: Print out a hard copy of your credit report and circle the items in question.
- Step 2: Draft up a letter of dispute to submit to the credit bureaus. For a template, click here.
- Step 3: Send the letter, the highlighted copy of your credit report, and any supporting documentation to the credit bureaus.
- Step 4: Follow-up in writing with the credit bureaus after 30 days if you still haven’t received a response.
If you need additional help with credit report errors, review this comprehensive guide from the FTC.
It can take a while for credit reports to reflect updates made by disputing errors. So, prepare to fix your credit at least a few months before applying for a mortgage. That way, you can ensure any positive changes have time to improve your credit.
What if everything is accurate?
There’s a possibility that a series of financial missteps or a rough patch has left your credit in shambles and the effects are lingering. If that’s the case, reach out to the creditors and request that they remove the negative mark from your credit report in exchange for a settlement of the account in question.
This is called a pay-for-delete agreement and can do wonders for your credit if the creditor is on board. But be sure to get the agreement in writing.
If the account is showing as a paid collection item, this approach won’t work since the account has already been paid off.
However, you can write a letter to the creditor explaining your circumstances and ask that they honor a goodwill adjustment so you can get approved for a mortgage. You may not have luck with either approach right away, but consistency could pay off.
Run the Numbers
Mortgage loans designed for consumers with subpar credit sometimes come at a higher cost. Why so? It’s all a matter of risk.
The mortgage lender wants to be protected if you default on the loan and the home goes into foreclosure. So, if you’re adamant about getting a mortgage with bad credit, be prepared for the financial implications.
To illustrate, assume you’re seeking a 30-year fixed-rate mortgage for $250,000. Below is an example of how the figures could play out, based on your creditworthiness:
|CREDIT SCORE||MONTHLY PAYMENT||INTEREST PAID OVER |
LIFE OF LOAN
|TOTAL COST OF|
And these figures don’t even factor in property taxes, homeowner’s insurance, and private mortgage insurance (if you make a down payment that’s less than 20 percent).
The good news is you can always refinance the loan at a later date when your credit score and financial situation improve.
An FHA Loan is a great option for anyone who wants to buy a house with bad credit. These loans are issued by private lenders, but the loan is guaranteed by the Federal Housing Administration. This guarantee protects the mortgage lender from borrowers that eventually default on their mortgage.
FHA loans come with less stringent requirements so they are easier to apply for than a conventional mortgage. However, FHA loans tend to have higher interest rates and closing costs than conventional mortgages.
FHA Loan Requirements
That being said, there are a few requirements you’ll need to meet:
- You need a minimum credit score of 580.
- You must have proof of a stable monthly income.
- If your credit score is 580 or higher, you’ll need a minimum down payment of at least 3.5%.
- If your credit score is 500 or higher you’ll need a minimum down payment of at least 10%.
- The home you’re purchasing must be your primary residence.
There are other requirements you’ll need to meet to qualify for an FHA loan. These loans are capped at a certain amount, though this will vary depending on where you live.
You’ll also have to work with an FHA approved lender and pay private mortgage insurance (PMI), which will increase your monthly payment.
See also: FHA Loan Requirements for 2023
If you’re a veteran who has bad credit, then you may be eligible to take out a VA loan. VA loans are issued through private lenders, but the mortgage is backed by the U.S. Department of Veterans Affairs.
The program is designed to help veterans get back on their feet and has served as a lifeline for many struggling veterans. And VA loans have many advantages.
There is no down payment required, and you don’t have to purchase PMI. Additionally, there is no minimum credit score requirement. The interest rates are very competitive, and it’s fairly easy to apply for a VA loan.
VA Loan Requirements
However, there are a few requirements you’ll need to meet first:
- Active duty military or a veteran who was honorably discharged.
- You’ve served for at least 90 consecutive days during active wartime.
- You’ve served for at least 180 consecutive days during active peacetime.
- More than six years in the National Guard.
If your spouse died in the line of duty you may qualify for the VA loan program as well.
The USDA typically offers these no-down-payment mortgage loans in rural areas and lower-density suburbs. To qualify for a USDA loan, borrowers must meet income limits based on their household size and the median income of their county. You must also have a minimum credit score of 580.
Consider Other Lending Options
If you aren’t a candidate for FHA or VA loans, you might consider alternative lenders. Loan aggregators like Credible are a good way to determine if you qualify for conventional loan products.
Lending Tree won’t give you a loan but will match you with mortgage lenders that are willing to work with you. It only takes a few minutes to sign up on the company’s website, and you can receive mortgage offers from multiple lenders.
If you’ve been banking with the same financial institution for an extended period of time, you might also consider applying for a mortgage there.
Banks tend to have stricter lending requirements, but they may be willing to consider you for a mortgage based on your long-standing history with the bank. At the very least, it can’t hurt to try.
Save Up for a Down Payment
Lenders may be reluctant to approve you for a house with bad credit. And the higher the loan amount, the more risk they’ll have to assume.
It is more likely that you’ll be approved if you put down a large down payment, since the loan amount will be lower. Plus, you’ll save a bundle on interest.
So, how much should you save for a down payment? The standard 20 percent required for most conventional loans is a good starting point, but the higher, the better. (Plus, you may be able to avoid mortgage insurance).
It’s also a good idea to have as much cash in your savings account as possible. This demonstrates to lenders that despite having poor credit, you can handle financial emergencies or cover unexpected financial occurrences as they arise. It’s not necessary to stow away an entire year of income in the bank, but three to six months will suffice.
Go Rate Shopping
Worried about your credit taking a hit if you apply with several lenders? Don’t be. According to myFICO, “inquiries for mortgage loans generated in a 30-day window count as a single inquiry.”
So, if you shop around and apply with ten separate lenders in a 30-day window, your credit will only be impacted by one inquiry since FICO scoring models recognize that you’re conducting a home loan search.
Sign on the Dotted Line
Congratulations! You’ve done your homework, saved up for a down payment, and shopped around to find the lowest interest rate. Despite your credit troubles, you’ve done the legwork to buy the home of your dreams.
But if you weren’t as fortunate and found that it wasn’t the right time to buy, don’t fret. Be patient while working diligently to boost your credit score and get your finances in order.
Furthermore, be sure to make all your rent payments on time to show potential lenders that you are responsible and can handle your housing obligations. That way, you’ll have more luck next time around.