Buying a home when you have bad credit is a difficult endeavor.
However, there’s a reason to be optimistic.
Many American’s are able to buy a house with bad credit in todays mortgage climate.
This article explains some things you need to do when you’re looking to buy a home with less than perfect credit.
1. Check your credit score
The first thing you need to do before looking into buying a house is to check your FICO credit score. There are many places online where you can check your credit and get your free credit score.
Credit Karma and Credit Sesame allow you to view your credit report and credit scores for free. You don’t need to sign up for a trail account using your credit card, these services vices are completely free.
You have three credit scores, one from each credit bureau. Mortgage lenders use your median credit score to rate your credit worthiness. When you have all three scores, throw out the highest and lowest score and you’re left with the middle score, this is the one lenders will use.
2. Fix errors on your credit report
If you notice any errors on your credit report you can dispute them with the three major credit bureaus. You can dispute just about any item on your credit report, from old street addresses to account information. You want to make sure your entire report is accurate without any mistakes.
3. Maximize your FICO scores
Before you apply for a home loan with a mortgage lender you will want to ensure your score is as high as it can possibly be. Here are a few things you can do to increase your FICO score before applying.
Dispute any errors
Once you have your credit score, you need to go through it to see if there are any errors. If there are any items you do not recognize, you can dispute them with the credit bureaus. The credit bureau will investigate the account giving the creditor 30 days to validate the account or it will be removed.
Pay down your credit card balance
Pay down the balances on your credit cards. The ratio of the balance on your credit cards compared to the credit limit is called your credit utilization ratio.
If you have a $1000 limit on a card with a $600 balance, your credit utilization ratio is 60%, which is considered very high. You want to pay down the balances on all of your cards as low as possible. The lower the balances are, the higher your credit score will be.
Get collection accounts removed
If you have any collections on your credit report, contact the creditor and see if you can do a pay for delete. Paying a collection account will not increase your credit score unless it is removed from your credit report entirely.
By correcting any errors on your credit report and paying down the balances on your credit card accounts you will maximize your credit score quickly. This is important so you can have the highest credit score possible when a mortgage lender pulls your credit report. This will improve your chances of being approved to buy a house with bad credit.
4. Find Low credit mortgage lenders
The term “bad credit home loan” is synonymous with FHA loans. FHA home loans are offered by FHA-approved lenders. The FHA has low credit score requirements of just a 500 score with 10% down.
However, lenders will each set their own credit requirements. Not all lenders will be able to work with low scores, you should contact multiple lenders to find one that can work with your scores.
5. Get pre-approved
Once you have found a lender that is able to work with you, you need to get a pre-approval letter. In order to become pre-approved your loan officer will need to pull your credit and verify your income and bank documents.
6. Find an agent and start house hunting
Once you have been pre-approved its time to start your home search. You will want to start with hiring a knowable real estate agent.
What are considered “good” and “bad” credit scores?
- 720+ = Excellent credit
- 680-719 = Good credit
- 620-679 = Fair credit
- 580-619 = Poor credit
- 579 and lower = Bad credit
FHA Home Loans
For people looking to buy a house with a bad credit score an the Federal Housing Administration created the FHA loan as an alternative to the harder to qualify for conventional loan.
The FHA mortgage is a favorite for many first-time homebuyers because of the low credit and down payment requirements. The FHA has a minimum credit score requirement of 500 with a 10% down payment.
You can pay just 3.5% down if you have a 580 or higher credit rating. However, just having a 580 FICO score will not guarantee you will be pre-approved for a mortgage, there are other factors involved.
Qualifications for FHA loans:
- 580 or higher FICO score
- 3.5% down payment
- Down payment can be a gift from a friend or family member
- Stable employment history
- Debt to Income ratio less than 43%
Factors that can Help you Buy a House with Bad Credit
Making a Large Downpayment
Saving up for a larger down payment can increase your chances of buying a house if you have bad credit. A large downpayment reduces the loan-to-value ratio making the loan less of a risk to the mortgage lender.
You just need a 3.5% downpayment for an FHA loan. However, if you have 10% to put down that will not only increase your odds at approval, it will reduce your PMI costs.
No Late Payments in the Last 12 Months
Just because you have a low credit score doesn’t mean that is the only thing a lender will see. If you had an unforeseen circumstance happen in your life such as a loss of income, or medical reasons that led to your poor credit.
Having 12 months of timely payment history shows you have re-established your credit history, even if your score hasn’t completely rebounded yet.
Having a low Debt-to-Income Ratio
Debt-to-Income is the amount of debt obligations you have compared to your income. If you do not have a car payment, or lots of credit card debt this is a good sign you can handle a mortgage payment.
Lenders want your debt-to-income ratio to be under 43% after factoring in the estimating monthly mortgage payment. If you are below 43% DTI it will reduce the risk to the lender.
Buying a House with Bad Credit
Even for borrowers with low credit scores the American dream of homeownership still exists, although with a higher interest rate. Make sure you check your credit and fix any errors.
Maximize your credit score by paying down your credit card balances. If you have collections, negotiate with them to remove the account if you pay them off.
Check your savings to see if you have extra money for a larger downpayment. Emphasize to the lender any compensating factors, like a long employment history, high income, or clean payment history over the past year. Stay optimistic, lots of people who have bad credit have been able to buy a house, you can to.
Many people ask the same question. how to buy a house with bad credit? While it’s not an easy task, it’s not impossible.
Once you have a copy of your credit report and scores you need to work on increasing your credit rating as much as possible. FHA loans are the best fit for consumers with a poor credit history. If you’re unable to get approved for an FHA mortgage you can work on improving your credit using using the strategies in this article or credit repair.
There may be other loan options if you have low credit scores. You should consult a loan officer to go over all potential options.
Randall has over 15 years of experience in the mortgage and credit industries. He spends a chunk of time helping consumers understand their credit, advise them on how to increase their credit, and lending his mortgage expertise to help them find the right type of loan. Randall lives in Dallas, Texas with his two sons.