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For most people, buying a house is the most significant financial investment they ever make. For some, it’s a somewhat painless process to qualify a mortgage with favorable rates. For others, it’s a bit more of a slog.
If you have bad credit, you may think buying a house will be impossible. But that’s not true. Prospective home buyers with bad credit can still qualify for mortgages, although the process may play out differently than for buyers with good credit.
In this piece, we explain why bad credit isn’t a deal breaker when you want to buy a home, and discuss how you can buy a house with bad credit. We’ll also offer some tips to help you qualify for a mortgage and increase your credit score to lower the barriers of entry to homeownership.
What is a ‘bad’ credit score when buying a home?
Believe it or not, most lenders don’t require a minimum credit score to approve a mortgage. Conventional lenders are free to set their own credit score requirements and, since no two applicants are the same, you may find a low credit score doesn’t preclude you from getting a mortgage loan. Outside of your credit score, lenders also look at:
- A borrower’s potential down payment
- A borrower’s overall amount of debt
- A borrower’s income
- If a borrower has debts in collections
Cash is a huge asset when applying for a loan and if you have enough for a substantial down payment — or a good, steady income — it may be enough to offset a bad credit score. Plus, you can also refinance your loan if your credit improves later.
All that said, the credit bureau Experian™ defines a “bad” or “subprime” credit score as anything below 670. A “fair” score is 580 to 669, while a poor score is 300 to 579. In real estate, you may struggle to find a mortgage if your credit score is below 620. Again, it’s not impossible, but any lender who will approve your mortgage will likely set an enormous interest rate and strict repayment terms.
Government-backed loans, however, do have minimum requirements and different rules depending on your credit score.
What are your loan options with bad credit?
Reiterating the previous section, lenders set their own minimums for income, credit score, and other factors to qualify for different loans. If your credit score is below 620, shop around. You may be able to find a loan that isn’t too punitive with interest rates, especially if you have a high income relative to your desired loan amount.
FHA loans are backed by the Federal Housing Administration and tend to have lower qualifying requirements. The minimum credit score to qualify for an FHA loan is 500, but minimums range based on the product you’re pursuing.
Generally, to get maximum financing on a primary home purchase, you should have a credit score of 580 or better. Credit scores ranging from 500 to 579 qualify for a little less financing. The FHA does, however, make allowances for loan applicants with a “non-traditional credit history or insufficient credit” if they meet certain requirements.
One other thing to keep in mind: If your credit score is less than 580, you’ll need to make a 10% minimum down payment to secure your loan. If it’s more than 580, you only need a 3.5% down payment.
Veterans and active service members can qualify for VA loans, backed by the Department of Veterans Affairs. These loans allow you to purchase a home with $0 down so long as you meet the specific standards to apply. However, like most conventional loans, you need a minimum credit score of 620.
Backed by the US Department of Agriculture, USDA loans let you buy a home in a qualifying rural area with a $0 down payment. Most lenders require a 640 minimum credit score to qualify for the loan, however.
Fannie Mae HomeReady® loans
If you don’t have a credit score, you may be able to qualify for mortgage provider Fannie Mae’s special HomeReady® loan. You can use alternative credit sources like bill payment history to demonstrate your capability to pay back the loan. That said, if you put down less than 20% as a down payment, you’ll need to pay for private mortgage insurance (PMI).
Freddie Mac Home Possible® loans
Fannie Mae competitor Freddie Mac also offers loans to borrowers without credit scores or with very low credit scores. If you don’t have a credit score at all, you must make a 5% minimum down payment; otherwise, the minimum is 3%. Like HomeReady® loans, you’ll need to pay PMI if your down payment is less than 20%.
What can you do if you can’t get a bad credit mortgage?
If you have a score of 500 or below, you’re going to really struggle to find a mortgage, even with help from government-backed programs. So what do you do if you can’t find a mortgage?
Increase your credit score
First and foremost, the best thing to do is just improve your credit score. Your credit score takes into account:
- Your history of paying your bills on time, in full.
- The amount of credit you’re using. The more credit you use, the lower your credit score may become.
- The average age of your credit accounts.
- How your credit is mixed between revolving credit (like credit cards) and installment loans (like car loans).
- How much new credit you have.
Increasing your credit score is a function of leveraging all of these tools. One of the best ways to improve your score may sound counterintuitive: Increasing your available credit. You can do this by paying down balances or requesting a limit increase from your credit card company. By increasing the credit limit without changing your spending habits, you decrease your credit utilization while continuing to pay your statement off on time.
Another thing you can do is open new lines of credit, so long as you can do it responsibly. Taking out a small personal loan or leasing a car before applying for a home loan adds some diversity to your credit mix and gives you a strong payment history. It will take a little time to reflect on your credit score — but if your score is under 500, you shouldn’t rush into buying a house anyway.
Increase your down payment
As we’ve touched on throughout this piece, increasing your down payment is a surefire way to give yourself a better shot at mortgage approval. Of course, that’s easier said than done. But if you can earn some extra money from a side hustle, get financial help from a family member, or benefit from an inheritance, you may soon have more cash for a down payment.
Otherwise, budgeting wisely and finding ways to cut expenses will help you free up cash. Also, consider putting any lump sums like tax refunds or bonuses towards your down payment.
Lower your DTI
Your debt-to-income ratio (DTI) is one of the most important factors that lenders take into consideration before approving a loan. If your credit score is bad, a better DTI could help your chances of approval.
DTI is your total debt, including your mortgage payment, divided by your gross monthly income. Most lenders will not approve a loan for an applicant with a DTI greater than 45%, though this varies. So, if your credit is bad, try to pay down some debt.
Pay to delete collections
Collections show lenders that you owe money and have not attempted to pay it back. When a debt gets forwarded to collections, it’s a terrible look on your credit report. (And may be why your credit score is so bad in the first place.)
Even if you’ve paid a collection, it can still remain on your report as a “Paid” collection. You can, however, request to have the collection expunged from your credit report. It’ll cost you some money but the resulting credit score increase may justify the cost.
Find a co-signer
Finally, depending on the mortgage, you might qualify for a home loan with a co-signer with a better credit score. A co-signer with good credit and a better DTI may give you the bump you need to get over minimums. If you’re home shopping with a partner or friend, you’ll need to get their approval to co-sign on the loan, but it could be the perfect resolution for your issue.
Buying a home with bad credit isn’t impossible. If you have a bad credit score, there are a number of loans you may still qualify for but you probably shouldn’t be in a rush to move in unless you’ve done a great job saving. Take some time to increase your credit score, pay down debts, and, if you can, save up.