In this post:
- Why Are Credit Scores So Important for Homebuyers?
- What Score Do You Need for a Conventional Loan?
- How to Buy a House with Bad Credit
- How to Buy a House with No Credit
- Improve Your Credit Score for the Best Homeownership Opportunities
Bad credit can make buying a home challenging if you’re like most homebuyers who need a mortgage loan to do the job. Mortgage lenders typically want to see a good credit score and solid credit history from a potential homebuyer.
Still, you don’t need to write off your dream of being a homeowner if you have poor credit or no credit. Instead, learn how to buy a house with bad credit by finding the right mortgage and working around your credit score.
Steps to Buying a Home with Bad Credit:
- Check Your Credit Report
- Review and Fix Your Current Finances
- Research Mortgage Options
- Get a Co-Signer
- Make a Sizeable Down Payment
- Ask for Manual Underwriting
The score on a credit report gives a mortgage lender a quick reference for what they can expect from a prospective homeowner as a borrower. Generally, a credit score reflects the amount of debt a person has, how frequently they borrow or attempt to borrow, and their payment history, all of which are important for a lender to know before they decide to hand over money for a mortgage.
The higher a credit score, the more reliable a borrower is, in theory. Higher credit scores typically go to borrowers who pay their bills on time, use their credit wisely, and don’t continuously try to borrow more money to consolidate debt or buy something they otherwise couldn’t afford.
A conventional home loan is the most common type of loan for homebuyers. It isn’t backed by a government agency, so lenders usually have stricter requirements for a conventional loan than they might for other loans.
Although requirements vary by lender, most conventional loans ask for a credit score of 620 minimum, although lenders often feel more comfortable with credit scores of 660 or above. The closer you are to 700, the better when it comes to buying a home.
How to Buy a House with Bad Credit
Getting a mortgage loan with bad credit is possible, but it’ll take a little extra work. Here’s what you need to know about how to get a mortgage with a less-than-ideal credit score.
Let’s start with something that you may not have even considered: Your credit score may not be as bad as you think, especially if you haven’t checked it in a while.
Checking your credit report annually is a must, but only about one-third of people do it. If you fall into the “I haven’t checked it in a while” category, now is the time. It’s possible that your report has inaccuracies that you can easily correct, like showing a balance on a credit card that you paid off a few months ago. Those simple inaccuracies could have an impact on your credit score.
If you do find errors, you can correct them with the credit reporting agency reporting the mistake by sending documentation supporting your case and a written statement to the agency.
Next, analyze your current financial situation. There might be some easy steps you can take to improve your credit score right now before you start searching for mortgage loans.
First, if you have any accounts taken by creditors, work on negotiating your balances. Many creditors would rather see some of a balance paid than none, so they are sometimes willing to negotiate a balance to get it settled faster. Once it’s cleared from your credit report, your score could increase.
Do you have a credit card or two that you can pay off or at least lower their balances? If you can consolidate your debt, you open up the amount of credit available to you, which boosts your credit score.
To whittle away at debt, you may need to review your budget. Are there subscriptions or other expenses that you can do without for a few months? Can you cook at home more instead of ordering takeout a few times a week? These small changes can add up to big savings, giving you more money to put toward your debts.
While you work to makeover your financial picture, consider enrolling in a free credit monitoring service, which alerts you when it finds changes impacting your credit score. Many of these services offer mobile apps for convenience.
Some types of home loans are specifically designed for borrowers with a lower credit score or income than what a conventional loan typically looks for. Their goal is to make homeownership affordable for most people, even those who have had financial hardships or are undergoing credit repair.
FHA loans reduce a lender’s risk in providing you with a mortgage because they are secured by the Federal Housing Administration (FHA), a government agency. Because of the lower financial risk, these loans are more lenient with their requirements than conventional loans. In most cases, homebuyers with a bad credit score – even if it’s in the 500’s – may qualify for an FHA loan.
FHA loans also come with other perks to help people with a negative credit situation, like down payments as low as 3.5% and allowable higher-than-average debt-to-income ratios.
USDA loans are backed by the United States Department of Agriculture (USDA) and have similar benefits as FHA loans, including lower down payment requirements and low credit scores from borrowers. A borrower must be buying a home in a USDA-eligible area and have qualifying income to get a USDA loan.
Despite being backed by a government agency, USDA loans still rely on mortgage lenders to furnish the loan. Mortgage lenders set their own credit score minimums, and many that offer USDA loans want to see scores of 620 or more.
Fannie Mae loans are bought by the governmental Fannie Mae agency from other financial servicers, like banks or lenders. Fannie Mae then secures the loans, similar to the USDA and FHA, to help borrowers who can’t qualify for traditional loans.
Fannie Mae offers a few different programs for various home-buying needs, but these loans generally provide low down payment options, eligibility with credit scores in the low 600’s, and the option to cancel private mortgage insurance once a homeowner gains enough equity in their home.
VA loans are strictly for qualifying service members and veterans of the United States armed forces. Not only can borrowers of VA loans qualify with a low credit score, but they also may become eligible for below-average interest rates, low or no down payments, and reduced closing costs.
If your credit score isn’t up to par with lender expectations, then adding a co-signer may be your best choice. However, your co-signer should have good credit to help boost the chances that you qualify for a mortgage loan.
A co-signer is another person who’s listed on your mortgage loan. Being a co-signer isn’t the same as being a co-borrower, who both co-signs the loan and becomes part owner of your home. A co-signer takes on the responsibility of paying your mortgage should you stop making payments. Therefore, asking someone to co-sign on your mortgage should be taken seriously, as any default in payment could end up on their shoulders.
A loan officer might be more inclined to approve a mortgage for a person with bad credit if they’re willing to make a larger down payment on their home. Not only can a larger down payment than what’s required reduce the amount the bank has to pay for your loan, but it also shows the lender that you’re serious about securing your mortgage and you might manage your money well.
Some types of mortgage lenders require up to 20% of the purchase price as a down payment, but others allow as little as 3%. Try to get above the minimum down payment requirement of your lender if you have bad credit. As a bonus, the more you pay now, the lower your monthly mortgage payment will be.
Before you can secure a conventional mortgage or another type of mortgage, your loan goes through an underwriting process, which verifies your information and determines if you qualify for the loan. Usually, this is done through automated underwriting to help speed up the process.
Homebuyers with bad credit should consider using a mortgage lender that provides manual underwriting, which is completed by a person rather than an automated process. Manual underwriting can ensure that the underwriter reviews information about a borrower’s credit and payment history in depth, which typically provides a more accurate and personalized view of their overall financial history.
When you want to secure credit in the form of a credit card, auto loan, or home mortgage, having no credit can sometimes be more challenging than having bad credit. With no credit, it’s difficult for lenders to determine your financial health because there’s no data for them to analyze.
Still, buying a house with no credit is possible by following many of the same steps you would if you had bad credit. However, you may need to furnish more proof of your income or have a co-borrower with a strong credit history to help you secure a mortgage.
The best action you can take to get the home loan you want, even if you have bad or no credit, is to work on improving your credit score. Boosting your score by even a few points can take time, but it’s well worth it to reap the benefits of not having a low credit score, especially when it comes to homeownership.
To learn what you should be doing to get a mortgage, reach out to a couple of mortgage lenders to learn more about their credit requirements. They can give you a few pointers to get your credit score closer to a number they want to see, like paying off a credit card or getting a secured credit card to build credit.
You might also explore alternatives to traditional homeownership as you work toward improving low credit to get approved for the home loan you want. For example, renting an affordable place or staying with family for a while as you build credit might be a good option. Or, look for rent-to-own opportunities in your area.
If you don’t know where to start, consider credit counseling. Credit counselors help the public improve their credit in personalized ways. They’ll work with you to set up a budget, review and cut back on spending, and lower your credit utilization. They can also connect you to programs to help you learn more about how credit works in your everyday life to build better financial habits for the future.