How to Buy a House With Bad Credit: Your Loan Options

Home Ownership how-to-buy-a-house-with-bad-credit

It’s possible to buy a house with “bad credit” (typically defined as credit scores below 630), but you’ll likely have to pay higher mortgage rates or a higher down payment than those with good credit.

That’s because lenders see those with poor credit as riskier borrowers who are more likely to miss payments or stop making payments entirely.

How low of a credit score is too low? It depends. In the first half of 2019, the average credit score of those who took out a new mortgage hovered around 730, according to data from the Federal Housing Finance Agency. That’s considered to be a good score. Of course, there were borrowers who had credit scores higher and lower than 730.

Meanwhile, during the same time period, only 4–5 percent of new mortgages went to borrowers with credit scores lower than 600. As your credit score decreases, it becomes much trickier (though not impossible) to obtain a home loan.

  • Credit score under 600: difficult, but not impossible to receive a home loan
  • Credit score in the 600s: fewer home loan options
  • Credit score 700+: many home loan options

how-to-buy-a-house-with-bad-credit

We’ll explore exactly how to buy a house with bad credit, from what credit score you’ll need to apply for certain loans to how you can raise your chances of getting approved if your credit score is not as high as you would like it to be.

Check Your Credit Score

Maybe you’ve rented your entire life, and you’re ready to own some property. First, you’ll need to check your credit score to determine your eligibility for certain types of home loans.

Aside from knowing your credit score, it also pays to comb through your entire credit report, which contains information about your credit history, account balances, payment history, collection items, and other records. If you find missing or incorrect information, you should dispute the report six months to a year before you want to buy a house to ensure that errors don’t hinder your ability to qualify for a home loan.

Here’s an overview of home loan options based on your credit score:

Your Credit Score Home Loan Options
Below 500 Few loan options; offer a higher down payment, find a co-signer, or work on increasing your score
500+ FHA loan with 10% down payment required
580+ FHA loan with 3.5% down payment required
620+ VA loan; conventional loan
640+ USDA loan

Credit Score Below 500: Boost Your Mortgage Approval Odds

FICO labels credit scores below 580 as “very poor.” With a credit score below 500, you likely won’t qualify for many types of home loans. However, if you’re itching for a white picket fence and a big backyard, you have a few options to increase your chances of securing a loan in the future.

Stash Cash for a Larger Down Payment 

In general, offering more cash up front signals to lenders that you’re serious about buying a house. Larger down payments can, in some cases, convince lenders to offer you a loan even if your credit score is considered “bad.”

Even if your credit score is considered fair or good, larger down payments reduce the amount you have to finance and your future interest payments.

Find a Cosigner 

Lenders are more likely to issue home loans if a cosigner with good credit is involved. It can be tricky to find one since cosigners are on the hook for making mortgage payments if you can’t.

Still, opting for a cosigner could be a good option for you if your credit score isn’t as high as you’d like it to be and you can find someone that’s willing to accept the risk.

Pay Off Other Debts 

Home lenders look at your debt-to-income (DTI) ratio, which compares how much you owe each month to how much you earn, and your credit utilization, which is how much credit you currently use compared to how much credit you have.

Keeping these ratios low boosts your credit score and can increase your chances of being approved for a home loan.

how-to-buy-a-house-with-bad-credit

Credit Score 500+: Consider an FHA Loan (High Down Payment)

FHA loans are loans issued by private lenders, like credit unions and banks, but backed by the Federal Housing Administration (FHA). That means that the FHA will pay the private lender if you default on your mortgage payments. Since the federal government guarantees the repayment of these loans, private lenders are typically willing to offer more lenient lending terms.

If your credit score lies between 500 and 580, you may be eligible for an FHA loan. However, you must provide a 10 percent down payment. Additionally, FHA loans typically require you to cover certain closing costs and maintain a DTI that’s below 50 percent.

FHA loans can be used to buy single-family homes, multi-family homes, condominiums, and certain types of manufactured and mobile homes. They can also be used to make certain home improvements.

Credit Score 580+: Consider an FHA Loan (Lower Down Payment)

If your credit score is at least 580, you could qualify for an FHA loan with a lower minimum down payment of 3.5 percent.

That’s significantly lower than the typical down payment. According to the National Association of Realtors, 2019 homebuyers made an average down payment on their homes of about 12 percent.

It’s important to note that, although FHA loans are backed by the federal government, private lenders can set stricter minimum requirements than the FHA guidelines. You should shop around and check out the terms that different lenders offer no matter what the circumstance is.

Credit Score 620+: Consider a VA Loan

Similar to the FHA, the U.S. Department of Veterans Affairs (VA) backs a home loan for veterans and active duty service members who meet certain service requirements, as well as for certain reservists, National Guard members, and surviving spouses of deceased veterans.

VA loans, which are issued by private lenders, can be used to buy a house as a primary residence or to refinance an existing loan. There is no minimum required credit score since the VA requires lenders to consider all of borrowers’ financial circumstances. However, many private lenders set a minimum credit score requirement of 620.

Most VA loans do not require down payments, but they do require certain income and property thresholds to be met. Additionally, there’s no specified DTI, but if your DTI is above 41 percent, you’ll need to provide proof that you can repay the loan.

Credit Score 620+: Consider a Conventional Loan

You’re probably familiar with conventional, or conforming, loans, which are loans not backed by the FHA, VA, USDA, or other government agencies. These loans typically require credit scores in the 620–640 range — and often higher.

According to the Federal Housing Finance Agency, the average credit score of those who took out conventional loans during the first half of 2019 was 750, which is considered very good. Despite the relatively high credit score requirements, some conventional loans allow borrowers to put down as little as 3 percent toward their down payments.

Credit Score 640+: Consider a USDA Loan

If you prefer to own a home in a rural or suburban area, you could qualify for a USDA loan, which is issued by private lenders and backed by the United States Department of Agriculture.

These loans, designed for low-income borrowers, do not require down payments and offer low-interest rates. Like a VA home loan, there’s no required minimum credit score. However, those with credit scores above 640 qualify for a streamlined credit analysis. That means that, when that credit score threshold of 640 has been met, “additional credit analysis (by private lenders) is not appropriate,” according to the USDA.

Those with credit scores lower than 640 can be considered for USDA loans but are subject to additional qualification requirements.

Can You Buy a House with No Down Payment and Bad Credit?

If you qualify for VA or USDA home loans, you don’t need to set aside a down payment. However, conventional loans almost always require a down payment if your credit score is low.

Should You Buy a House With Bad Credit?

how-to-buy-a-house-with-bad-credit

Just because you’re approved for a home loan doesn’t mean you should necessarily take it. Some financial experts recommend that no more than 28 percent of your gross monthly income should go toward your mortgage payment, property taxes, and insurance. You may want to hold off on borrowing if you will exceed that percentage.

Remember that it is possible to buy a house with bad credit using loans backed by government entities and other methods. However, to receive the best terms possible, it often makes sense to prioritize paying off debt and raising your credit score first.

Sources: Federal Housing Finance Agency | Federal Housing Administration | National Association of Realtors | U.S. Department of Veterans Affairs | U.S. Department of Agriculture

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