Buying A House With Bad Credit: A Guide To Your Home Loan Options
Andrew Dehan7-minute read
January 10, 2023
The thought of buying a house can be overwhelming. Starting the home buying process with bad credit can make it seem nearly impossible to get a loan, but did you know there’s such a thing as a bad credit home loan? Your credit might not be as much of a roadblock as you think.
In this post, we’ll talk about buying a house with bad credit, understanding your credit score, how to qualify for a mortgage andincrease your score quickly.
What Do Mortgage Lenders Consider A Bad Credit Score?
Most borrowers don’t know this, but many lenders don’t require a specific minimum credit score to buy a house. The catch-22 is that a conventional mortgage lender is free to set their own requirements when it comes to your credit score. Although government-backed loans give mortgage lenders some peace of mind, they still have credit score requirements, even if they are usually much lower.
If you have a credit score lower than 500, you might find getting a mortgage a bit hard and will probably need to focus on increasing your score first.
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Can You Buy A House With Bad Credit?
When it comes to the actual number, anything less than a 670 FICO® Score is considered “bad” or “subprime,” according to Experian™, one of the three main credit bureaus. More specifically, a fair score is 580 to 669, while a poor score is 300 to 579. The thing about having poor credit is that it’s not the same as someone else’s bad credit.
No two situations are the same, and outside of your actual score, lenders will also be looking at things like:
- How much the borrower has available for a down payment
- The borrower’s overall amount of debt
- How much income the borrower earns
- If the borrower has any debts in collections
Cash is your best friend when you have bad credit and the more of it you have to use toward a down payment, the better. The reason for this is that your credit score might only qualify you for a certain mortgage loan amount. If you can cover the difference with cash, you can still afford the home you want.
The lender you end up with will also play a factor because all lenders will have different requirements. While you can get a bad credit loan, you must be prepared to pay a higher monthly mortgage payment due to much higher interest rates.
Don’t forget, if you purchase a home with bad credit, you can always repair your credit and refinance your mortgage for much better loan terms later on.
How To Buy A House With Bad Credit
Let’s check out some of the loan options available and the average credit score requirements for each of them.
There isn’t a set minimum requirement for income, credit score or down payment to qualify for a conventional loan. However, the minimum credit score required to qualify for a conventional mortgage loan is usually a 620 or better.
There are exceptions, though. If you have high income compared to your loan amount or a larger than minimum down payment, it might be easier to qualify for a conventional loan, even if you have a score a bit lower than 620.
The minimum credit score needed to get an FHA loan is 500.
FHA loans also have additional qualification requirements. For instance, you can use an FHA loan only to purchase a primary residence.
If you’re a veteran or currently serving in the armed forces, you could qualify for a VA loan.
A VA loan is backed by the Department of Veterans Affairs and allows for the purchase of a home with $0 down. Some lenders may have you pay a one-time “funding fee.”
As with FHA loans, your home must meet specific standards to qualify. And while the VA has no specific credit score minimum, most lenders do. Rocket Mortgage® for example, has a 580 minimum credit requirement.
A USDA loan* is another loan backed by a government department, the U.S. Department of Agriculture. A loan from the USDA allows you to buy a home in a qualifying rural area with a $0 down payment.
Most lenders will require a 640 credit score to qualify for the loan, along with other income requirements specific to a USDA loan.
*As of July 6, 2020, Rocket Mortgage is no longer accepting USDA loan applications.
Options For Buyers Who Can’t Get A Bad Credit Mortgage
The best home loan option for you if you have bad credit depends on how low your score is. If your score is below 600, you probably should look into an FHA loan or VA loan.
Of course, the best option is to work on repairing your credit score before you submit a mortgage application. While this is not the answer borrowers want to read or hear, it’s the most practical and can save you thousands in interest payments. Not only will you have more mortgage options, but you might be able to get your loan with a lower income requirement and down payment.
Of course, as stated above, if you have a score of 500 or below, you probably won’t be able to do anything except wait until you increase it. Also, if you’re looking to buy a house with a bankruptcy on your credit, you will need to wait at least 2 years before a lender will start considering you for a new mortgage.
You can take the necessary steps to grow your score by understanding the following:
- Payment history: Your payment history is responsible for 35% of your score. This is the main reason people are continually saying “pay your bills on time” regarding your credit score.
- Credit utilization: The amount of credit you are currently using is also known as your credit utilization and is responsible for 30% of your score. The more credit you’re using, the higher your credit utilization, the lower your score can become. It would help if you looked to keep your total credit usage under 30%.
- Age of credit history: This is most often referred to as your “average age of accounts” and is one of the few factors you have almost no control over. Your credit history is basically the age of your oldest credit account, new credit accounts and the average ages of all the accounts on your credit report. The length of your credit history makes up 15% of your score.
- Credit mix/types of credit: When you look at your report, you’ll notice that there are a few different types of credit on your report. Those can be revolving credit (like credit cards) or installment loans (like car loans or personal loans). Having a mix of credit is a good thing for your score, and it is responsible for 10% of it.
- Amount of new credit: Having an account less than 6 months old is usually considered having new credit. Your score will be impacted whenever you add a new account because it will give you a hard inquiry and decrease your average age of accounts. Be mindful when applying for new credit as it contributes to 10% of your overall score.
Increase Your Available Credit
Once you get a better handle on things and have started improving your score, increasing your available credit can help raise it a little faster. You can do this by either paying down balances or making a credit limit increase request. This effort helps increase your credit score because you will decrease your credit utilization, which is a huge factor in determining your score. Remember, it’s best to have a higher credit score to buy a house and apply for mortgages.
And guess what: Most credit card companies allow you to request as many increases as you like without it causing a hard pull on your credit.
Add New Accounts (In Bulk)
Adding new accounts also means you’ll be increasing available credit and increasing your overall credit mix. Doing this in bulk is even better because it puts everything in the same time frame. Your inquiries will all fall off on the same day, any new accounts will age together, and you’ll add more available credit to your report.
This change also allows you to establish an even stronger payment history on your credit report. It usually takes less than 30 – 45 days to see the effects of adding bulk, new accounts to your report.
Pay For Deletions
One of the worst items you can have on your credit report is a collection. Collections show lenders that you owe money to someone and have not attempted to pay it back.
Even if you pay the collection off, it can remain on your report as “Paid,” which is better than having an outstanding collection. However, the best result which will help even more is to request the items be deleted from your credit report if you make a latepayment.
Before making a payment for deletions, make sure you get the transaction in writing. It will be like you never received that collection, thus increasing your credit score and giving lenders one less reason to decline you.
Stay Away From Hard Credit Inquiries
While getting an insurance quote won’t affect your credit score, applying for any type of new credit will. Having too many hard inquiries on your credit is not a good thing.
When applying for any type of financial transaction that requires a credit pull, always check if it’s a hard or soft pull. Avoid doing anything requiring a hard pull close to when you apply for a mortgage.
Find A Co-signer
Depending on your mortgage, you may be able to qualify for a home loan with a co-signer. This addition can help bump you over the credit threshold as the co-signer’s income and assets will be considered along with yours. You may also qualify for a larger loan amount with a co-signer, even with bad credit, which can give you a bigger budget when shopping for a home.
In most cases, a co-signer will only help lower your debt-to-income ratio, which by itself helps with qualification. Another person's income and assets will make it easier for you to afford for a higher monthly mortgage payment. Most of the time, the lowest median credit score of all borrowers on the loan is the one that counts. However, if multiple borrowers are getting a loan backed by Fannie Mae, the guidelines allow for lenders to average median scores of the borrowers. This can mean the difference between qualifying or not getting the loan.
For example, if you have a median credit score of 580 and your co-signer has a score of 720, you couldn't qualify with both incomes until recently. Now Fannie Mae policy, in many instances, is to average the scores, coming out at 650. You can get the loan.
It's important to note that for the purposes of determining your interest rate and mortgage insurance cost, the lowest median score is still used, so your rate may be slightly higher. Additionally, the averaging of credit scores doesn't apply to every loan option. We encourage you to speak with your Home Loan Expert.
The Bottom Line On Bad Credit Home Loans
Having bad credit doesn’t mean you can’t enjoy the benefits of homeownership. Instead, it might just require additional research when looking for financing.
With a loan backed by the government like an FHA loan, you can qualify for a mortgage even with a 500 credit score. It might be tempting to buy a home as soon as possible, but it’s better to take the time to assess available options and interest rates while you start shopping for a loan.
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