Bad credit can be a big problem when buying a house, given the amount of money involved and the extra cash needed to buy a home with bad credit.
According to data from Lending Tree, a bad credit score can eat away at your financial assets to over $45,000 throughout a lifetime.
Unfortunately for Americans with bad credit, life’s largest purchases – such as a home, an auto, or college – require stellar credit to qualify for loan financing and get the lowest interest rates possible to save money on a 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 when trying to buy a house with bad credit. It’s a tough list, but knowing the challenges ahead 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 riskworthiness 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 – Get Report) ).
FICO credit scores range from 300 to 850, with 300 anchoring the bottom rung of credit score health and 800 being 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 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) even to 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 mortgage insurance. Hence, 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 expenses 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 lay a blueprint for buying 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 buying a home with bad credit. The trick is to take that knowledge and build up from there, doing what you must 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 has no minimum credit score requirements and offers several low-down-payment home purchase options. Thus, an FHA loan is the Holy Grail for buyers with low or no credit buying a home.
Not every private lender will go forward with an FHA-insured loan (although many do), so make sure you know about going in on any home lender due diligence and ensuring your lender supports 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 also handles FHA-insured loans and won’t burden you with onerous charges 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
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 important and can significantly heighten your chances of landing a good mortgage.
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 – giving 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
Suppose you can get an FHA-approved mortgage loan, great. That will clear the way to get a home loan without breaking the bank in building a 20% home down payment.
That said, accumulating a big down payment fund is still highly worth the effort. 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, 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 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 increase the odds of getting a mortgage; once you get approved, it also allows you to move in, improve your credit, invest in your home, and watch it appreciate.
It will also teach home maintenance lessons to improve home value appreciation skills.
Additional “Help” Factors
Homebuyers with bad credit can 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 a down payment and have relatively low interest rates.
Or, if you live in a rural area, the U.S. government can interest 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 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 – where you’ll have a great place to live, raise a family, and plug yourself into a good community.
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