This article will go over some of the loan options available to first-time buyers with bad credit and ways you can increase your score to increase your odds of getting approved.
First-Time Homebuyer Programs by State
As a first-time homebuyer, there are many programs that provide financial assistance to help with the down payment and closing costs. All homebuyer programs for each state can be found below.
Low Credit Score Loan Options for First-Time Buyers
FHA loans are government-backed mortage loans that are guaranteed by the Federal Housing Administration. They require a 580 credit score with a down payment of 3.5%, a 10% down payment is needed with a 500-579 credit score. A mortgage insurance premium (MIP) is required along with an upfront MIP fee of 1.75% of the loan amount.
- 580 credit score with 3.5% down
- Mortgage insurance required
- 50% maximum debt-to-income ratio
HomeReady / Home Possible Loans
The HomeReady and Home Possible Loan programs are mortgage loans for low-income created by Fannie Mae and Freddie Mac for low-income first-time homebuyers with a 620 or higher credit score. Borrowers need just a 3% down payment. Income cannot exceed 100% of the area median income (AMI).
- Minimum 620 credit score
- Income below 100% of AMI
- 3% down payment
VA loans are for veterans of the U.S. military, they are guaranteed by the Department of Veteran’s Affairs and issued by private mortgage lenders. A VA mortgage is a home loan you can get with no money down. including 100% financing and no mortgage insurance. Most lenders require borrowers to have a minimum 580-640 credit score to qualify for a VA loan.
- For qualified veterans
- Minimum 580 credit score required
- No down payment
The U.S. Department of Agriculture guarantees USDA loans for low-to-median income borrowers looking to buy a home in a rural area. A USDA mortgage is a no money down home loan available to low-income borrowers whose income is below 115% of the area median income (AMI) with a 620 credit score. You must purchase a property located in a USDA-eligible location.
- Minimum 620 credit score
- 100% financing (no down payment)
- Income must be below 115% of AMI
A conventional loan is a home loan that is not guaranteed by the government but by private mortgage insurance (PMI) companies. There is an annual PMI premium if you have less than a 20% down payment. They require a 620 FICO score with a down payment between 5% t0 20%.
- Minimum 620 credit score
- 5%-20% down payment
Credit Requirements for a Mortgage
Mortgage lenders look at your entire credit history, not just your credit score, to determine if you qualify. Items such as late payments or multiple collection accounts could prevent you from getting approved even if you meet the credit score requirements.
- No Credit History – If you’ve never had credit in your name, you may not have a credit score. A lender can use alternative credit lines, like utility bills, phone bills, and rent payments, to establish a positive payment history.
- Bankruptcy – If you have had a bankruptcy, it won’t disqualify you. Most mortgage loans require a 24-48 month waiting period after a bankruptcy to qualify for a mortgage. You must have re-established positive payment history since your bankruptcy.
- Late Payments – A single late payment will not automatically disqualify you. However, you should not have any more than one late payment on any of your accounts in the past 12 months.
- Foreclosure – There is a 36-month waiting period after you have filed for foreclosure. Some borrowers may qualify in 12 months with extenuating circumstances.
- Collections, Judgements, and Federal Debt – Lenders may verify that judgments and Federal debt have been paid or on an agreed-upon payment plan. Collections will not disqualify you. If your total collection debt is over $2,000, your lender may require you to make payment arrangements before closing.
Improve Your Credit Score Before Applying
Your credit score not only determines if you qualify for a home loan, but it’s also the biggest factor in the interest rate you receive. So improving your score before getting a mortgage can save you a lot of money. There are ways for most people to improve their credit scores quickly. You can get a free copy of your credit report once per year at www.annualcreditreport.com.
- Pay down debt – The amount of available credit you’re using is called your credit utilization ratio. The higher the balances on your credit cards is, the lower your credit score will be. Credit utilization accounts for 30% of your FICO score; only your payment history has a bigger impact. Try to pay your balances to less than 25% of your card’s limits.
- Dispute inaccurate information – If you find anything you don’t recognize, you can file a dispute with the credit bureaus. They have 30 days to reach out to the creditor to verify the account; if they can’t, the credit bureau must delete it.
- Pay your bills on time – Your payment history makes up 35% of your credit score. Paying your bills on time is the best thing you can do to improve your credit. If you forget to pay your bills sometimes, it’s best to set up auto-pay.
Tips for First-Time Homebuyers
Search for Local Down-Payment Assistance Programs
If you’re a first-time buyer with low-to-moderate income, you may be eligible for first-time homebuyer down payment assistance or grants. These programs help with the down-payment and closing costs making it easier to become a homeowner. You can for state programs through the HUD website.
Your local city and county will also have assistance programs that are available listed on their website. If you qualify for one of these programs, it will make buying a house with poor credit less difficult. You will be required to meet specific guidelines and will have to take a homebuyer education class.
Shop around for the Best Mortgage Rate
Your interest rate and closing costs will vary depending on the lender. It’s recommended that you get a loan estimate from 3-4 different mortgage lenders to make sure you’re getting the best mortgage rate. FICO allows a 30-day “Rate shopping” window, where multiple inquiries from mortgage companies within 30 days will count as a single inquiry.
Ask the Seller to Pay some of Your Closing Costs
Most types of home loans allow the seller to pay a portion of the buyer’s closing costs. This will need to be negotiated into the purchase agreement. The amount of seller-paid closing costs varies but most mortgage programs allow the seller to pay 3% to 6% of the costs.
The Bottom Line
If you’re a first-time homebuyer with bad credit, it’s more difficult to get approved for a home loan, but not impossible.
There are mortgage programs such as FHA home loans available to borrowers with a credit score as low as 500 with 10% down or 580 with 3.5% down.
If possible, spend some time working on improving your credit score before you apply.
Are you ready to get pre-approved for a mortgage?