How to Buy a House with Bad Credit: Read These 3 Tips First
The term “bad credit” may be the financial equivalent to a four-letter word. But with so many Millennials facing unprecedented amounts of student loans while entering adulthood in a recovering economy, having bad credit shouldn’t be embarrassing.
In fact, the average credit score for Millennials is a 638, well below the national average of 675. But that doesn’t mean you can’t move forward with your life, especially if you want to buy your own house.
I’ll walk you through exactly what you can do to boost your mortgage application into the “yes” pile.
What credit score do you need to buy a house in 2019?
The exact credit score you’ll need depends on the kind of loan you get and the lender you work with. FHA loans, for example, have a minimum score of 580 if you want to pay just 3.5% of the home purchase price for your down payment. If you have less than a 580, you could still potentially qualify for an FHA loan.
What’s the catch?
You’ll automatically have to make a 10% down payment on your home. That’s a big jump. On a $200,000 house, for example, a 3.5% down payment would be just $7,000. A 10% down payment on the same home would be $20,000. That’s a lot of cash required!
Other loan types typically require a credit score between 620 and 640.
Ultimately, it’s up to your lender to decide on minimum credit scores. They may require a higher score, even for an FHA loan. A good lender can walk you through all your options so you know the pros and cons. Don’t be afraid to be upfront with them and ask thorough questions. Obviously, there’s going to be some type of trade off if you qualify for a home loan with bad credit.
Get details from your lender on what those trade offs are.
Is the interest rate high? What about private mortgage insurance? Will you need a larger down payment?
These are the questions you should be asking lenders as you shop around for a mortgage bad credit.
How can you buy a house with poor credit?
Now that you have an understanding of what the lower threshold of credit scores is for most mortgages, let’s talk details. I’m going to show you three ways you can buy a house with poor credit (and why they help you):
Picking the right home loan.
Saving up for a bigger down payment.
Paying off your other debt.
Let’s dig in!
#1: Pick the Right Loan
We talked a bit about loan types and minimum credit scores, but there are other things to think about when choosing the right loan.
If, for example, you don’t have a lot of cash on hand, you may wonder how you can buy a house with bad credit and no money down. There actually are a couple of options.
USDA loan. Sponsored by the U.S. Department of Agriculture, USDA loans don’t require any down payment at all! Of course, there are some restrictions. You’ll need to meet some income requirements based on where you live and how many people are in your family. And the home you’re buying needs to be in a designated “rural” area.
Don’t worry, that doesn’t mean you have to have cows for neighbors (but if you’re like me, you may prefer them!).
We actually used a USDA loan for our first home, which was in a popular county and only 10 minutes away from civilization. Much of the surrounding area was either state park or horse farms, but there were also plenty of traditional neighborhoods, so don’t automatically discount the USDA home loan program just because it’s “rural”.
VA loan. This one is restrictive in that you or your spouse need to be an active member of the military or a veteran. Your lender can help you get your certificate of eligibility (COE), which is needed to qualify for a VA loan. Again, this one comes with no down payment required and a minimum credit score of 620.
I’ve heard from family members that the requirements for the home’s condition are quite strict with VA loans. It’s meant to protect you as a buyer, but I’ve literally heard of a wobbly stair railing needing to be fixed by the seller before the loan could close. Definitely no fixer uppers with this one!
State-sponsored down payment assistance programs. Many states offer down payment assistance programs, which often comes in the form of grants.
What does that mean for you? Free money!
With a little smart research and strategic planning, you can increase your chances of buying a house with bad credit and no down payment.
#2: Save for a Bigger Down Payment
If you don’t qualify for one of these loans because of your credit score, consider taking some more time and saving up for a bigger down payment. This can help compensate for your bad credit score when buying a house, and there are actually two ways this happens.
First, a bigger down payment gives the lender more confidence that you’re invested in the home and won’t miss payments to the point of going into foreclosure. If that happens, you wouldn’t get any of that initial cash back.
A bigger down payment also helps lower your monthly mortgage payment because your loan will be a smaller amount. That helps you qualify because your debt-to-income ratio will be lower. So even if you have other existing debt, your mortgage payment will take up a smaller piece of the pie.
Get creative with your budget, set a goal, and stick to it!
#3: Pay Off Your Debt
Paying off your debt is another way that can help you buy a house with bad credit. Just like the last tip, it’s going to automatically lower your debt-to-income ratio, which can help you qualify for a home loan. A major debt payoff can also help boost your credit score — and fast. This is especially true for credit card debt.
Here’s an example. When we were in the process of selling our previous home, we did a lot of last minute updates and had to address some repairs from the buyer’s inspection. We charged a few thousand dollars to our credit card, and I noticed that my FICO score dropped nearly 100 points (I get free monitoring through my bank). As soon as we paid off that card with some of the closing proceeds, my score went back up to over 800.
Bottom line: don’t underestimate the impact credit card debt has on your credit score.
Is buying a house with bad credit right for you?
The answer to this question depends on why you have bad credit. If you’ve got your financial footing back in place and can afford not only the monthly payments and also the ongoing maintenance that comes with a house, then homeownership could definitely be a smart choice.
But if you’re already going to have a hard time supporting monthly payments, or maybe don’t have a secure job situation, then it might be best to wait. There’s always going to be another house out there, and you can easily make it your dream home when the time is right.
Frequently Asked Questions
Can you buy a house with bad credit?
Yes, having low credit score doesn’t necessarily preclude you from buying a house. The downside is that you’ll pay a higher interest rate and in many cases, may require a larger down payment. For young professionals, jumping from paying a 3.5% down payment to a 10% down payment can be the difference between buying a home and renting for a few more years.
Is rent to own a good idea?
Renting to own your home allows you to lock in a price now while leasing the property you intend to purchase at a future rate. Rather than orchestrating this through a traditional lender, your financing is provided by the homeowner - who also happens to be your landlord. You keep paying rent but the amount includes an additional component called option money. It goes towards the down payment; however, if you decide not to buy the house at the end of the rental period, you’ll forfeit the option money you paid.
How can I fix my credit quickly to buy a house?
In addition to paying down debt, also make sure your credit report is completely accurate. Too often people have incorrect negative items impacting their scores. Get a free copy of your credit reports at AnnualCreditReport.com.
Even if all of the information is correct, you can figure out what’s bogging down your score. At the same time, make sure you make all of your current bill payments on time and get your credit utilization down to 30% or less for each credit card you have. If possible, also consider becoming an authorized user on a family member or friend’s credit card. As long as they have a positive history, it’ll count for your credit as well. Just know that any negative entries for that card will impact both of you as well.