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Having bad credit is challenging, but it doesn’t mean you can’t qualify for a new home loan. Instead, bad credit usually means you won’t be eligible for the best interest rates and terms.
Even if you can buy a house with bad credit, it’s important to educate yourself on the homebuying process.
In this guide, we’ll help you understand what you have to do to buy a house when you have a low credit score, and the steps you can take to set yourself up to get better terms in the future.
Can I buy a house with bad credit?
It’s possible to buy a house with bad credit, but there are caveats. For one, you may not be eligible for all types of mortgage options, particularly those with the lowest interest rates and most favorable terms — those typically go to people with good credit scores. Or the lender may require a larger down payment.
In addition to meeting credit history, income, and debt-related eligibility criteria, you’ll usually have to meet a lender’s minimum credit score qualifications as well. You can learn about lender requirements and compare mortgage rates from multiple lenders with Credible.
What’s a bad credit score?
Using FICO’s scoring model, here are the factors that make up a credit score.
- Payment history: Your history of paying current and past credit accounts as agreed makes up 35% of your FICO credit score.
- Credit utilization: Credit utilization is the amount of available credit you’re using. If you’re using most of your available credit, lenders may think you’re overextended and at risk of defaulting. Credit utilization accounts for 30% of your credit score.
- Length of credit history: This credit score factor is worth 15% of your FICO score. It takes into account the average length of time your credit accounts have remained open. Generally, high credit achievers have longer credit histories than those with lower credit scores.
- Credit mix: Your credit mix, which accounts for 10% of your credit score, refers to the types of different credit accounts you have — credit cards, personal loans, auto loans, mortgages, and so on.
- New credit: When you apply for new credit, hard inquiries can impact your credit score for 12 months.
When you’re shopping for a new mortgage, you may see advertisements that mention borrowers with “good” or “poor” credit. But what do these terms mean?
Most credit score ranges include …
- Excellent: (750 and above)
- Good: (700 to 749)
- Fair: (640 to 699)
- Poor: (less than 640)
Generally, the minimum credit score you’ll need to qualify for a conventional mortgage is 620, according to Fannie Mae. But you may be eligible for a Federal Housing Administration (FHA) loan with a minimum credit score of 580 and a 3.5% down payment. The FHA provides some loans to borrowers with a 500 FICO score, but the agency requires 10% down in that situation.
What to know about buying a home with bad credit
It’s helpful to understand what lenders are looking for on mortgage applications. Here are some general eligibility guidelines to consider.
- How much down payment you need: Depending on the lender, you may be able to snag a home loan with a minimum of 0% or 3.5% down. The more down payment you have, the more creditworthy you’ll appear to lenders.
- Debt-to-income ratio (DTI): Lenders usually look for a debt-to-income ratio of less than 50%. The lower your DTI ratio, the more borrowing options will be accessible to you.
- Private mortgage insurance (PMI): If you can put 20% down, you can usually avoid paying private mortgage insurance, saving you significant money over the lifetime of the loan.
<liLoan to value ratio (LTV): The loan amount compared to a home’s current market value affects the interest rate you’re offered. For example, if your LTV is on the higher end, you may receive higher interest rates. That’s because you might appear riskier to lenders if you have less equity in your home.
Types of mortgage loans for people with poor credit
Consider these types of mortgage loans, which could provide a pathway to homeownership, even if you have bad credit.
- FHA: FHA loans are government-backed mortgages with easier credit qualifying guidelines. With a median credit score of at least 580, you may be able to qualify for a mortgage with a 3.5% down payment.
- VA: The Department of Veterans Affairs insures VA loans for military veterans, active-duty service members, and their spouses. The VA doesn’t impose minimum credit requirements, but individual lenders may set their own requirements.
- USDA: The U.S. Department of Agriculture backs these 0% down loans for low-income applicants in eligible rural areas.
- Conventional: Generally, conventional loans are much harder to qualify for than government-backed loans. But some mortgage lenders offer their own in-house programs to make it easier to qualify first-time buyers.
How to buy a home with bad credit: 7 steps
If your credit score is less than you’d like it to be, you could work to improve your score and shore up your financial profile to give yourself more loan options and the opportunity to save money.
Here are seven steps you can follow to improve your chances of getting approved for a mortgage loan.
1. Check your credit. You may know your credit is bad, but looking at your report and score can help you identify opportunities for improvement. On top of that, a 2013 Federal Trade Commission study revealed that 20% of consumers had one or more errors on at least one of their credit reports. You’re entitled to free copies of your credit report once a year from the three major credit bureaus — Equifax, Experian, and TransUnion.
2. Get prequalified. Prequalification can help you understand how much home you can afford, and it shows lenders you’re a serious buyer.
3. Save toward a down payment. Although some loans for poor credit may not require a down payment — such as USDA loans — having a down payment can be a big advantage. A down payment of 20% or more could help you avoid PMI, and help lenders and sellers view you as less of a risk. Plus, making a down payment ensures you have instant equity in your new home.
4. Comparison shop. Shopping around can help you find a loan that works best for you. Credible can help you compare mortgages from multiple lenders.
5. Research first-time homebuyer programs. If you’re a first-timer, programs are available to help with down payment assistance and other aspects of homebuying.
For example, many lenders accept Fannie Mae’s HomePathⓇ Ready Buyer Program for first-time homebuyers, which Fannie Mae defines as someone who hasn’t owned a home in the past three years. Eligible borrowers may receive up to 3% in closing cost assistance.
6. Get pre-approved. A mortgage loan pre-approval is a more rigorous and accurate assessment of your buyer qualifications than a prequalification. a A pre-approval reassures sellers that you’ll likely be able to secure a mortgage when you make an offer on their house.
7. Work with an experienced agent. A real estate agent experienced in working with first-time buyers or lower-income buyers can help you navigate the home- buying process.
Pros and cons of bad credit home loans
Just because you can get a mortgage with bad credit, it doesn’t always mean you should. Buying a home with bad credit can have a positive effect on your credit if you’re able to manage monthly mortgage payments and other expenses, or a bad one if you can’t juggle all your financial obligations.
Pros of bad credit home loans
- May improve your credit: Consistently paying your mortgage on time every month could improve your credit.
- Owning is often cheaper than renting: Your monthly rent payments help the landlord cover their mortgage, which means you may be paying more than the property is worth, or the difference may be minimal.
- Owning a home builds equity: When you own a home, you have an asset that increases your net worth. And with every monthly payment, you’re building more equity in your home.
Cons of bad credit home loans
- May harm your credit: If you become overextended and unable to make payments on time or miss payments, your credit score could drop significantly.
- Higher mortgage rate: Generally, borrowers with bad credit pay more for the same loan amount, which could add up to tens of thousands of dollars in interest over the long haul.
- Difficulty covering other home expenses: If your monthly income means you have a tight budget, a bad credit home loan could leave you stretched too thin to cover repair costs, homeowners association fees, and other home-related expenses.
Alternatives to buying a house with bad credit
Buying a home with bad credit isn’t your only choice. Consider these three alternatives to getting a mortgage loan.
Wait until you can improve your credit
Rather than applying for a mortgage loan with a potentially unfavorable interest rate, you may find it worthwhile to push the pause button. You can then work to improve your credit score.
Making consistent on-time payments can help improve your credit. Paying off credit card balances to reduce your credit-utilization ratio may also help your credit score. And, until you’re ready to apply for a mortgage, avoid opening new credit accounts that you don’t need.
Consider a cosigner
A cosigner with good credit might help you qualify for a better interest rate and terms. Help protect your relationship with your cosigner by setting clear expectations from both parties before accepting any money.
A rent-to-own arrangement with your landlord can help you become a homeowner. Typically, you’ll pay a premium in addition to your monthly rent. The extra money goes into an escrow account and ultimately becomes your down payment.
However, these agreements are often very complex and are risky in several ways. As with any financial arrangement, make sure you do your due diligence to understand the benefits and risks.
When you’re ready to look for a mortgage, Credible makes it easy to compare rates from multiple mortgage lenders.
About the author: Tim Maxwell began his career as a broadcast news writer and field journalist. He later worked in digital media roles at 20th Century Fox and NBC Universal before becoming a full-time personal finance writer. Tim’s work has appeared in several publications, including USA Today, Washington Post, Bankrate, LendingTree, and Credible. He also publishes Incomist, a personal finance site that focuses on paying off debt by earning extra income in creative ways.
When he’s not writing, Tim loves pursuing new adventures with his family in the Sierra Nevada mountains. Tim received his bachelor’s degree in mass communications from Fresno State University. You can find him on Twitter or on LinkedIn.