Buying a house with bad credit is an uphill climb, but it is doable.
There's no question that bad credit can be a big problem when buying a house, given the amount of money involved and the amount of extra cash needed to buy a house with bad credit.
Unfortunately for Americans with bad credit, life's largest purchases - such as a home, an auto or college - require stellar credit, not only to qualify for loan financing but to get the lowest interest rates possible to save money on the loan.
Having bad credit makes that task much more difficult. But with a double dose of discipline and ingenuity, you can still buy a house with bad credit and work on building up your credit score from there.
Challenges of Buying a Home With Bad Credit
There are myriad obstacles in your way when trying to buy a house with bad credit. It's a tough list to look at, but knowing the challenges that lie ahead of you gives you a road map to buying that house, toxic credit or not.
These will be among your biggest challenges:
Lenders Count on Your Credit Score to Rate You as an Investment Risk
Mortgage lenders lean heavily on credit scores to determine your risk-worthiness before approving a home loan.
The formula for that determination is straightforward and is based on calculations and rankings created by Fair Isaac Corp (Better known as FICO FICO ).
FICO credit scores range from 300 to 850, with 300 anchoring the bottom rung of credit score health and 800 being at the highest credit score range.
Your credit score is based on a combination of personal financial traits, like your ability to pay back debts on time, the amount of debt you've accumulated, your mix of credit accounts, and any negative information attached to your name from lenders and creditors.
If your credit score is 600 or lower, mortgage lenders will likely deem you a high credit risk, and may either reject your mortgage loan outright or approve the loan but only with an ultra-high interest rate attached making the home that much more expensive.
You Won't Get the Same Breaks as a Buyer With a Stronger Credit Score
Homebuyers with robust credit scores get breaks that buyers with lower credit scores likely won't get.
For example, a buyer with a good credit score (say, 700 or above) may not likely have to put a lot of money into the home upfront, in the form of a down payment. In that case, a 5% or 10% down payment will get the job done, based on their solid debt repayment history.
A homebuyer with a weak credit score doesn't get that treatment. A buyer with a 590-credit score will be expected to generate a higher home down payment (20% is a common target) to even begin to qualify for a home loan.
You'll Pay More in Closing Costs
Homebuyers with low or no credit usually have to pay more in closing costs, if they're fortunate enough to get a loan in the first place.
Aside from the conventional closing costs attached to a new home loan contract, low-credit buyers may have to put aside money in the form of mortgage insurance, so lenders have a line of defense if the borrower defaults on the mortgage loan.
The amount of money is usually tied to the monthly loan payment - the lower the credit score, the more months' worth of payments a low-credit buyer will need to put aside.
You May Need to Take Extra Education Steps to Qualify for a Loan
Some lending institutions may require low-credit or no credit homebuyers to attend an approved homebuyer education course - and you'll still need to come up with that bigger down payment.
Use These Tips to Buy a Home with Bad Credit
Okay, with the bad credit headwinds out of the way, let's flip the script and layout a blueprint on how you can buy a home with bad credit.
Again, it is a difficult task, but it is a doable one.
You already know the roadblocks ahead of you and there's an advantage in that alone in buying a home with bad credit. The trick is to take that knowledge and build up from there, doing the things you need to do to clear the way and get that "approved" stamp on your home mortgage loan.
The following tips can take you all the way home - literally:
1. Aim for an FHA Loan
A U.S. Federal Housing Administration (FHA) loan comes with no minimum credit score requirements and does offer several low-down-payment home purchase options. Thus, an FHA loan is the Holy Grail for buyers with low or no credit in buying a home.
Note that not every private lender will go forward with an FHA-insured loan (although many do), so make sure you know going in on any home lender due diligence and make sure your lender support FHA loans.
2. Aim for Flexibility
The hunt for a qualified lender is narrowed with bad credit but good candidates are out there.
Remember what you're looking for in a lender who can handle a buyer with bad credit. You want a lender who not only will overlook toxic credit but one that also handles FHA-insured loans and one who won't burden you with onerous fees, based on your credit score.
Each lender you encounter will have some credit score criteria, so there's no getting around that.
But some mortgage lenders are more flexible on credit scores than others, and it's up to you to find them. Start with a good, reliable online mortgage lender platform like LendingTree.com, or Rocket Mortgage from Quicken Loans, both of whom offer access to multiple loan options for consumers with low- or no-credit, and where borrowers who have bad credit can earn a break or two on loan terms.
3. Upgrade Your Credit Score
Yes, improving your credit score is an obvious tip toward a low-credit mortgage, but that doesn't mean it's unimportant. Boosting your credit score is very important and can significantly heighten your chances of landing a good mortgage deal.
That's why it's always a good idea to check your credit score with all of the three major credit reporting bureaus (Experian (EXPGY) , Equifax (EFX) - Get Report or Transunion (TRU) - Get Report) well ahead of starting your actual search for a mortgage. Six months ahead is a good rule of thumb - that gives you enough time to improve and showcase a stronger credit score.
You can review your credit for free at annualcreditreport.com.
When you get your report, scan and check for any errors and report any discrepancies to the credit reporting bureau that has listed the information. Look for areas of score growth opportunities, like taking care of old debt and paying down new debt - always - on time.
Those are your best options to quickly improve your credit score and position yourself to land a good mortgage deal.
4. Save for a Good Down Payment
If you can get an FHA-approved mortgage loan, great. That will clear the way for getting a home loan without having to break the bank in building a 20% home down payment.
That said, it's still highly worth the effort to accumulate a big down payment fund. Number one, it attracts more lenders who love borrowers with ample down payment cash, and the more lenders you have in a home purchase scenario, the better deal you'll get.
Additionally, the more money you put down for a down payment, the less you'll owe on the total cost of your home.
For example, the difference in putting 5% down on your home versus 20% can result in tens of thousands of dollars in savings, as both your mortgage principal and loan interest will both be lower with a high down payment.
5. Aim for a Lower-Priced Home
Your chances of landing a home mortgage with bad credit increase the lower the total cost of a home. Here, the math is in your favor, as a lender will be more willing to take a chance on a low-credit score borrower at $100,000 than they would at $300,000.
Consequently, aiming for a low-cost starter home can not only increase the odds of your getting a mortgage, once you get approved, but it also allows you to move in, improve your credit, invest in your home and watch it appreciate.
It will also teach you the home-maintenance lessons that will improve your home value appreciation skills down the road.
Additional "Help" Factors
Homebuyers with bad credit can also get into a new property by thinking creatively and leveraging alternative home loan opportunities.
For instance, if you're a military veteran, you likely qualify for a Veterans Loan, a guaranteed home loan through the U.S. Department of Veterans Affairs. These loans don't require any down payment and come with relatively low-interest rates.
Or, if you live in a rural area, the U.S. government can offer you a USDA-insured loan through the U.S. Department of Agriculture. They too, don't need a down payment and the mortgage you get through the USDA must go to a primary residence purchase.
Don't Let Bad Credit Hold You Back
While bad credit certainly isn't advisable in any personal financial scenario, you can still buy a home with bad credit if you know what to do and know where to look.
Follow the tips above to land a home mortgage that works for you, and paves the way for a stronger financial future - one where you'll have a great place to live, raise a family, and plug yourself into a good community.