Buying a home is entirely possible with bad credit, but it’s harder and more expensive than for people with great credit. Before you begin the home buying process, you should ask yourself why you want to become a homeowner. Homeownership comes with many significant and unforeseen costs that can be difficult to cover if your financial situation is unstable. Continuing to rent indefinitely or until your credit improves may be the best financial choice for you.
Key points to remember
- Try to improve your credit score as much as possible before shopping
- Consider all initial and long-term costs of an FHA loan before taking out one.
- Try to improve your overall financial situation as much as possible to improve your chances of getting approved for a conventional loan.
FHA Loans – Your Bad Credit Loan Option
Federal Housing Administration (FHA) loans are FHA insured loans, but are actually issued by any FHA approved lender. FHA loans were created to help low- and moderate-income borrowers become homeowners. If individuals cannot get approved for conventional mortgages, FHA loans are the remaining option for hopeful homebuyers with bad credit.
FHA loan requirements
- Credit score as low as 500 with 10% down payment or as low as 580 with 3.5% down payment.
- Debt ratio of 43% or less
- Verifiable income for 2+ years
Improve your credit score
Taking a few steps to improve your credit score before you buy from home will improve your shopping experience exponentially. In today’s hot real estate market, many home sellers are less likely to choose offers with low down payments that will force them through the FHA’s rigorous appraisal process. Improving your credit score can help you get a conventional mortgage and get better deals on homes that are more likely to be accepted.
- Pull your credit report to see why your credit is low and check for errors. This is free once a year from Experian, Equifax and TransUnion on AnnualCreditReport.com.
- Pay off all revolving lines of credit to improve your credit utilization percentage. This usually results in an immediate jump in score.
- Have all errors removed from your credit report, especially late payments
- Consider visiting a credit repair service to see if your score can be improved enough to save you the cost of their reduced mortgage rate fees.
Why You Should Improve Your Credit Score Before You Buy
Even improving your credit score by just a few points before you buy can save you thousands of dollars. If increasing your score allows you to be approved for a conventional mortgage instead of an FHA loan, you will save the initial mortgage insurance premium of 1.75% of the loan amount. Additionally, conventional loans tend to have lower closing costs and interest rates than FHA loans.
While both FHA loans and conventional loans will require monthly mortgage insurance if you’re paying less than 20%, an FHA loan includes monthly mortgage insurance for the term of the loan that you can only get rid of by refinancing and paying the fees. closing on a new loan. In the case of a conventional mortgage, the private mortgage insurance falls off when your loan balance is equal to 80% of the value of the property.
Optimize the rest of your borrowing profile
Your credit score isn’t the only factor that goes into loan approval. You can increase your chances of being approved for a loan on favorable terms even with bad credit by optimizing the other parts of your borrowing profile.
Putting more money on your mortgage essentially means that you are putting more of your own collateral into the loan and the lender sees you as less likely to default and a lower risk borrower. If you’re struggling to find a down payment, there are many unique ways to bolster your funds. Some areas even have down payment assistance programs.
Improving your debt-to-income ratio (DTI) can also help you get approved for a mortgage with bad credit. If you can pay off or get rid of some of your monthly debt like a car loan, your DTI will improve. Increasing your income by taking a second job will also improve your DTI. The easiest way to improve your DTI is to buy homes at the bottom of your budget. If you determine that you can afford a home up to $300,000, but your credit score is still lower than you would like, you can increase your chances of being approved for a mortgage if you choose a home. which costs $250,000.
Lending options for unique populations
If you meet certain criteria, you may qualify for a VA loan or a USDA loan. Both types of loans allow you to deposit 0% without paying private mortgage insurance and do not require a minimum credit score, making them a much cheaper option than FHA loans.
You generally must be a veteran who served for certain periods or under specific circumstances or be the surviving spouse of a veteran under specific circumstances. VA loans are issued by private lenders but backed by the VA. You must have a certificate of eligibility from the VA to obtain a VA loan.
These loans are generally made in areas designated as rural by the USDA, and borrowers must meet income eligibility limits based on their county’s median income and household size.
Is it harder to get a mortgage with bad credit?
Yes. Bad credit makes it harder to get a mortgage. Fewer lenders offer FHA loans than conventional loans.
Can I get a conventional mortgage if I don’t have a 20% down payment?
Yes. You can get a conventional mortgage with as little as 3% down, provided you meet the lender’s other requirements for credit score, income history, and debt-to-equity ratio.
Do I have to pay for credit repair before shopping at home?
Try to get an estimate from the credit repair service of how many points they can improve your score and the total cost of their service. If they can improve your score enough to qualify for a non-FHA mortgage, you’ll save 1.75% on the initial mortgage insurance premiums ($1,750 per $100,000 of home), which will likely offset the cost. credit repair service. You may be able to improve your credit score on your own, so do your due diligence.
While it’s possible to buy a home with bad credit, it might not be the best choice. FHA loans are a great tool for borrowers, but changes to the program after the subprime mortgage crisis make them a very expensive lending product. Potential borrowers should do the math to see how much improving their credit and having more money to deposit could save them before rushing into the home buying process.