how to buy a house with bad credit

Buying a home isn’t always a bed of roses. The yin and yang of interest rates in 2023 are out of this world, and for those with bad credit, it adds even more stress to the mix.

Although getting a loan with a bad credit history may seem nearly impossible, there are ways to buy a home with a great credit score.

This article will review how to buy a house with bad credit, including in-depth steps to make it happen.

What is considered bad credit?

The minimum credit score requirements will vary for any given mortgage lender or loan. However, the lowest possible credit score is 300. In its entirety, the credit score scale ranges from 300 to 850.

What is the lowest credit score for a mortgage?

Generally, a homebuyer wants a credit score of at least 580. You may still be eligible for an FHA loan if you are right on that 500 score. We’ll look at this in more detail below, but specific to getting a mortgage, borrowers are less likely to get a mortgage if their credit score is less than 500.

Financing options for buying a home with bad credit

For those thinking about buying a home with bad credit, the good news is that you have options. Let’s review what is available for buying a home with bad credit.

conventional loan

Conventional loans are among the most popular loans for homebuyers. In 2021, they accounted for 74% of mortgages in the US, according to the Origination Insight Report by ICE Mortgage Technology. You’ll find these loans at commercial banks and savings and loan associations.

Generally speaking, you will need a credit score of at least 620 when applying for a conventional loan. Approval is possible with a low credit score, but you’re likely to see higher interest rates. And you know what that means – higher payouts. You want to consider putting down at least 10% for a conventional loan.

FHA loan

FHA stands for Federal Housing Administration. The administration favors an FHA loan and generally allows little change with regards to credit score. These are great home loans for bad credit borrowers with 500+ scores. However, lenders are more susceptible to accepting people with scores of 580+.

There are some conditions with this type of loan. For example, an FHA loan requires you to use the loan to purchase a primary residence, and the lender requires you to pay FHA mortgage insurance premiums, also known as MIPs. MIP protects the lender from loss if, for any reason, the borrower is not able to repay the loan.

usda loan

The US Department of Agriculture supports the USDA loan. A USDA loan allows you to buy a home in a qualifying area with a zero down payment. Remember that the USDA doesn’t technically have a credit score requirement, but many lenders require a 640 credit score to qualify for this loan.

Like other loans, you must meet conditions to qualify, such as earning a certain amount each year and buying property in a particular area. Find out if you qualify for this loan on the USDA’s website. It is worth noting that there is no down payment requirement for these loans.

VA loan

Are You Eligible for a VA Loan? You may qualify if you are a veteran, the spouse of someone who served in the military, or are currently serving in the armed forces.

The Department of Veterans Affairs supports VA loans and allows people to buy homes with zero down. In most cases, you’ll pay a one-time funding fee. The funding fee is a one-time fee paid to the Department of Veterans Affairs, which supports the VA home loan program. Technically, there is no minimum credit score required for a VA loan.

Local and State Buyer Assistance Programs

Can you get money from grants or forgivable loans? It’s time to find out if you qualify for down payment help. Yes, it’s a lot. Payment assistance can help someone with bad credit, especially when offsetting a bad score with a healthy down payment.

Learn more about down payment assistance and see if you qualify.

How to improve your credit score before getting a mortgage

Step by step, isn’t it? There are specific steps you can take to improve your credit score before officially applying for a bad credit home loan.

Monitor Your Credit Score

You can request a free copy from each of the three major consumer reporting companies (Equifax, Experian, and TransUnion). Visit AnnualCreditReport.com to obtain copies from the bureaus.

Each company offers a nice online user interface to make checking your credit as often as possible. If you spot an error, each credit bureau has a process for correcting errors and outdated information.

Check Your Credit Report for Errors

An FTC study found that at least 20% of people had at least one credit report error. Therefore, it’s important to make sure you’re not just going off the calculated FICO score you can find on your credit card statement.

reduce your credit utilization

Do you know your Credit Utilization Ratio? Credit utilization ratio measures how much credit you have used compared to your total credit availability, and overall, it severely affects your credit score.

If you’re wondering how to buy a home with bad credit, take a look at what debt you’re already in. Another metric of mortgage lenders is the debt-to-income ratio. Chase recommends keeping your debt-to-income ratio at or below 43%. Although the debt-to-income ratio doesn’t directly affect your credit, it’s important to pay attention to it.

pay on time every time

Well, this is very important. Paying on time helps you avoid pesky late fees, but it also helps your credit. Even making minimum payments on your credit cards shows lenders that you are on time and responsible.

Avoid opening new accounts

Are you looking for a new credit card or a new car? No. Inquiries or purchases like these can lower your credit score, and too many of them are a red flag for lenders. Wait until you buy a home to make the next big purchase.

Keep old accounts open (even if you don’t use them)

Paying off debt is important, but keep those credit cards open. That zero-dollar balance is like showing off a fancy car that you own but don’t drive. It’s nice, but you don’t need it. A zero-dollar balance and unused credit are attractive to lenders because it shows that although the money is there, you are not dependent on it.

Options for Buyers Who Can’t Get a Bad Credit Mortgage

For buyers who can’t get a bad credit mortgage but your dream home is on the market, it’s not the end of the world. If you are looking for additional options on how to buy a home with bad credit, here are a few.

find a co-signer

If you have bad credit, it may be because you have a history of not paying your bills or your credit utilization rate is too high. There is always the option of co-signing. If you don’t pay back the loan, the co-signer, whoever it is, has to be fine and anyone will be able to collect the loan.

hard money loan

Hard money loan is a short term, secured and non-conforming loan. For context, a nonconforming loan doesn’t meet Fannie Mae and Freddie Mac’s standards. This loan comes from individuals or private companies that accept an asset or property as collateral.

If a borrower, say a person with bad credit, defaults on a secured loan, the lender can take ownership of the asset, ie the borrower’s home, to make up for his loss. A hard money loan typically comes with higher interest rates, and credit scores don’t matter, so it’s actually not a bad credit home loan option for people with low credit scores.

land contracts

Land contracts are a great alternative to traditional mortgage financing, especially if you have bad credit. The payment structure is similar to a mortgage, except that the buyer pays the owner or seller of the real estate until the full purchase price is paid.

Remember, You Have Choices

Can you buy a house with bad credit? Sure, bad credit mortgage loans do exist. A great credit score isn’t a dealbreaker, but it is a challenge when buying a home with bad credit. As each person is different, so are the lenders.

Remember that you have options. While shopping around, you may find that some rates are lower than others, or that the terms may be better with a certain lender. If you have bad credit, it is important to explore all your options.

Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.