Buying a house is one of the biggest decisions that we make in our entire lives. It’s natural to feel apprehensive about it.
It’s challenging enough to qualify for a mortgage if you have a good credit score, so it’s only normal to worry about your chances of getting a house loan approved if your credit doesn’t look so good.
You’ll be delighted to hear, though, that while buying a house with bad credit can prove a bit challenging, it’s not entirely impossible. Far from it. There are a few things that you can do to improve your chances of landing that house deal. Let’s go ahead and explore them.
Establishing Some House Rules for the Home Buying Process
When it first comes to the home buying process, we need to answer a couple of questions to establish some important facts. The first question has to do with identifying the “lowest” credit score that will still enable you to buy a house. Next, do mortgage lenders care about bad credit scores for potential clients to begin with?
In general, what is considered a low or bad credit score will vary by lender, but you can generally consider a score below 580 to be considered bad credit by most loan officers. However, a credit score of about 500 to 579 may still allow you to buy a house. It’s important to know that having such a low score categorizes you as having bad credit, certain mortgage lenders are actually lenient with their loan application processes.
Not that they like a bad credit score, but they will often still give you a chance. Although, we need to point out that lenders will naturally have more peace of mind if an applicant does have a good credit score, applicants with good scores certainly enjoy a few more benefits. Again, decisions and benefits vary from one lender to another.
Benefits of Building Your Credit Score
If you have a credit score of less than 500, you might apply for a housing loan, but we would encourage you to first build up your credit rating before doing so. You will need a lot of patience in the process, but you can certainly achieve the goal.
There are significant perks to having a good credit score. These include lower down payments, qualifications for additional loan options, more mortgage opportunities with no restrictions, faster approvals, and lower interest rates. These perks should inspire you enough to build up your credit score first to at least 600 or so before applying for a mortgage.
So, Can You Buy a House with Bad Credit?
The answer is a resounding yes. With a credit score of 500 to 579, you may still qualify for a mortgage. However, please take note that you’ll be limited to a federally-back loan like those insured by the FHA (Federal Housing Administration).
You will also need to shell out at least a 10% down payment, and the lender will most likely require you to pay outstanding collections as well as judgments prior to approval.
It’s also very important to take note that your bad credit is not the same as another person’s bad credit, so don’t get discouraged or compare your situation to that of anyone else.
Consider these other important factors that a mortgage lender will look at before approving your loan. Sample factors are:
- The borrower’s ability to pay for the needed down payment
- The borrower’s current debt
- The borrower’s income
- The status of the borrower’s debts (such as in collections or charged off)
It’s also important to note that if you the lender won’t qualify you for the full purchase price of the home but you have the ability to cover any difference using cash you have already saved, then that means that you might still buy the house you are targeting. Also, don’t forget to work on repairing your credit score even if you’ve already been approved for a loan. This will pave the way for better benefits in the future.
Always check your credit profile before applying for any loan. Knowing where you stand can guide you to your next steps and the loans and terms that you are currently qualified for.
Tips on Buying a House with Bad Credit
Pay Off Existing Debt
This is why experts always suggest paying your bills on time. Your payment history is very important and will affect huge borrowing decisions in your life such as buying a house.
Did you know that your payment history is highly influential in your credit score? Yes, it is. About 35% of your credit score reflects your payment history. So, if you are late on any debt payments, then get caught up to the best of your abilities.
Mortgage lenders also look at what is called your DTI ratio or debt-to-income ratio. It’s a pretty straightforward statistic comparing your monthly gross income to your required monthly debt payments. This will give mortgage lenders a good idea as to how much you might afford to spend on your monthly expenses, such as a home loan.
The preferred DTI ratio of mortgage lenders is anything below 36%. So, aside from working on building up your credit score, if you have a high DTI ratio, we highly recommend that you work on paying off your debt too and start paying bills on time moving forward.
If these aspects all look good to your prospective lender, then your chances of getting a housing loan approved will significantly rise.
Keep Your Budget Realistic
If it’s about buying your future home, then chances are you’ve thought about it over and over again. You’ve certainly thought about your budget for it. If you haven’t, then please do so. This is a decision that will affect your life for the next 15 to 30 years and also be a massive financial undertaking.
Searching for and deciding on your desired house is one thing, but being realistic with what you can afford is another. If you’re not realistic with your budget, then it will become even more challenging to buy a house with bad credit.
Make sure to balance your expenses by estimating them and then tracking them to confirm what you spend your money on monthly. Can you afford homeownership for 15 to 30 years alongside your other monthly expenses? Take note that with bad credit, you are most likely to pay higher interest fees.
Save Up for a Down Payment
The down payment for a housing loan is one of the biggest aspects that will affect any lender’s decision-making process. The math is simple: the more you can afford to pay upfront as a down payment, the less money you will need to borrower and, consequently, the smaller your monthly payment will be.
Plus, every dollar you pay upfront is a dollar not incurring interest over the life of your loan, so you’re saving even more money. What’s a good down payment? About 20% of your target home’s price.
There are two elements to consider here and these are LTV and PMI:
- LTV or the Loan To Value ratio refers to the value of your chosen home to the amount of your loan. You can calculate this by dividing the loan amount you want or you apply for by the purchase price of the home. So, for example, let’s assume the house you picked is worth $200,000 but you put down a $30,000 down payment. To get the LTV ratio, you divide the $170,000 loan by the $200,000 home value. If the result yields higher than 80%, then lenders might charge you more interest.
- PMI means Private Mortgage Insurance. It’s directly connected to the LTV ratio of your chosen home. Some lenders will actually require you to pay a PMI if you have an LTV ratio higher than 80%.
If you can afford to be patient, just take a look at how the ability to put up a desirable down payment can help secure you a house even with bad credit.
Know the Loans that You Can Take Advantage Of
We also encourage you to familiarize yourself with the different home loans you can take advantage of whether you have bad credit.
Conventional loans are readily available for those who’ve got a credit score at or above 620 or so above, and they often don’t require a minimum income or down payment. FHA loans are for those with what’s considered bad credit i.e. 500 to 579.
VA loans are also within reach of veterans with a credit score of 620, and USDA (US Department of Agriculture) loans by those with a credit score of 640 and above.
Get a Co-Signer
Simple yet very practical advice to get your chances on that housing loan raised is to get a trusted co-signer for it. The lenders will consider the income and assets from both of you, so if your co-signer has a good credit standing, it can increase your credit threshold significantly.
A larger loan amount might still be within your reach if you have a co-signer, giving you a wider range of house options.
Building your credit score back up to a desirable level is always a good idea before you start the home buying process. However, don’t be discouraged if you want to know what your options are now even if you currently have bad credit.
It will require a lot of patience and can be a quite challenging, but you’ll most likely pay more than those who’ve got good credit scores overall if you find your credit rating in the challenged or poor category. Still, the goal of owning a house is highly achievable even at this point.
Need assistance in accomplishing all the necessary steps to build up your credit score and eventually get approved for buying a house? Contact us, and we’ll be more than willing to give you a helping hand towards realizing one of the biggest decisions of your life.
About the Author
Rick has been in the financial and credit counseling industry for over 20 years. He is currently a HUD certified housing counselor and has well over a decade of experience as a certified credit counselor. Rick writes regularly on matters relating to consumer finances and is a contributor for many publications on these topics.