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What You Need To Know If Bad Credit Is Halting Your Home Buying Dreams
Contrary to popular belief, it is still possible to buy a new home even if your credit score is less than perfect.
By: Catie Kovelman, Updated 03/17/2022
Ideally, when you decide it’s time to start house hunting you’ll be able to come up with a 20% down payment and have good credit to help you secure a great mortgage. But unfortunately, we don’t live in a perfect world and that’s not always possible. And without a perfect credit history and down payment, many people assume no mortgage lender would even be willing to give them a home loan. But with our current economy, homeownership would be completely unobtainable if there weren’t workarounds in place for people with less than perfect credit scores to enter the real estate market. Therefore, it is possible to purchase a new home even with poor credit.
First, it's important to understand how bad your credit score actually is as this will impact your home loan interest rates and what options are available to you. Ideally, mortgage lenders like to see FICO scores above 700, and scores above 750 are particularly stellar. When the number drops below 700, your mortgage broker may start to question how much risk they will be taking on by supplying your home loan. That said, home loans are available for people with a minimum credit score of 500. So while it's possible to qualify for a mortgage with poor credit, how bad your low credit score actually is will impact your home loan's interest rate, restrictions put in place, and where you can get approved.
Raise your credit score.
If you don't need to buy immediately, it wouldn't hurt to take some time to improve your credit score before you start house hunting. This will make you more appealing to mortgage lenders and could help you obtain a more desirable home loan. First, obtain a copy of your credit report from the credit bureau or through services like Credit Karma. You should check your credit score through the credit bureau or Credit Karma at least once a year. Carefully check your credit report closely to see if there are any errors that are negatively impacting your credit score. Just like people, creditors are far from perfect and may make mistakes when reporting consumer slip-ups. If a mistake has been made, your FICO score could have dipped due to no fault of your own and can now be corrected. If no mistake has been made, you'll get a clear picture of your current credit history and can create an action plan for credit repair.
That said, there are plenty of actions you can take to improve your credit score. For example, you can pay off big expenses once and for all, such as what you might owe for car purchases or in school debt. Similarly, do your best to pay your credit card down completely each month. If you can't do that, at least make sure you are paying the minimum amount due on time each month and not missing any payments. This will help improve your payment history. Don't close old credit accounts or apply to new ones if you can avoid it, and instead focus on keeping the accounts you already have current. Lastly, try to adhere to a budget and limit your credit card usage. At a maximum, your outstanding balance should be 30% or less of your total available credit.
Target mortgage loans for people with low credit scores.
While they won't be the best mortgages offered by lenders, there are home loans that are still perfectly suitable for people with less-than-perfect credit scores. If you've already read our article about how to buy a home with a low or no down payment, these loans will sound a bit familiar to you. If you have a credit score of at least 580, you may be able to qualify for an FHA loan with a down payment as low as 3.5%. FHA loans are insured by the Federal Housing Administration and are meant for buyers with limited savings or a low credit score, making it a viable option. If your credit score has plummeted to 500, you may still be able to qualify for an FHA loan with a higher down payment.
Additionally, you may be able to apply for a USDA loan if you have a FICO credit score of at least 640 and want to buy a home in eligible rural and suburban areas. In addition to checking your credit score, mortgage lenders will want to see that the borrower has a debt to income ratio of 45% or lower and that the combined gross household income doesn't add up to be 115% or more of the median income of the county your home is in. To learn more about eligibility requirements or to apply for a USDA loan, click here.
If you, your spouse, or a family member has served in the military, you may also be eligible to apply for a VA loan. The mortgage is guaranteed by the Department of Veterans Affairs and allows military members, veterans, and eligible family members to obtain a home loan with competitive interest rates and no down payment. While the VA doesn't set a standard for minimum credit scores that must be met to qualify for a VA loan, individual lenders who provide VA loans can set their own minimum score requirements.
While these loans are viable options to allow you to become a homeowner with a bad credit score, keep in mind that you still may end up paying more in the long run. Because lenders view home buyers with poor credit scores as a significant risk, you may be stuck with a higher interest rate or required to pay mortgage insurance until you've paid back at least 20% of what you owe for your home's mortgage. This means your monthly mortgage payment may be higher, which will need to be worked into your monthly budget and cost of living. You will ultimately have to decide if the pros of home ownership outweigh the cons, or if it would be better for you to focus on raising your credit score before beginning your house hunt.
Increase your down payment.
If your credit score is a problem but cash flow isn't, you can make yourself more attractive to lenders by putting down a larger down payment. By putting down more money upfront, you are decreasing the risk the lender takes by providing your home loan. Therefore, increasing your down payment on a conventional loan from the standard 20% to just 25% or 30% will make mortgage lenders feel much better about investing in you. Your negative credit score could still mean you have to pay a higher interest rate, but increasing your down payment may mitigate this.
Learn more tips and tricks for buying or selling homes at the Dabl Real Estate Hub!