How To Buy A House With Bad Credit: 5 Expert Tips

Buying a house has become synonymous with “the American dream.” However, far too many prospective buyers have found that owning a home comes complete with a lot of prerequisites. In addition to coming up with enough money for a downpayment, there’s one hurdle that has proven hard for many to overcome: learning how to buy a house with bad credit. Fortunately, a low credit score won’t prevent a borrower from buying a home. While options may be more limited, buying a house with bad credit is possible—so long as you know where to look and the appropriate steps to take.

What Do Mortgage Lenders Consider A Bad Credit Score?

Contrary to what many believe, today’s mortgage lenders do not establish the benchmark of a good or bad credit score. The majority of mortgage lenders, in fact, neglect to require a minimum credit score in return for their services. Instead, the quality of a credit score is entirely dependent on the cumulative data provided by three main credit bureaus: TransUnion, Equifax, and Experian.

Borrowers’ credit reports are largely dependent on the information generated by these three credit bureaus. However, instead of relying on three independent reporting agencies for their information, mortgage lenders will generally look to the cumulative FICO scores to determine how creditworthy a borrower is. A FICO Score is a three-digit number based on the information in the previously mentioned credit reports, and indicates how likely a borrower is to repay their loan.

There are five primary credit score categories prospective homebuyers may fall under (according to FICO):

• Poor: Less than 580

• Fair: 580 – 669

• Good: 670 – 739

• Very Good: 740 – 799

• Exceptional: 800 or more

According to the latest FICO scores, anything less than 670 is bad—or subprime. It should be noted, however, that mortgage lenders will consider more than a borrower’s FICO Score. In particular, lenders will also consider the following:

• The borrower’s down payment

• The amount of debt the borrower has

• How much income the borrower makes

• Whether or not the borrower has any debts in collections

Anyone interested in learning how to buy a house with bad credit must first look into what today’s lenders view as acceptable; only then will borrowers be able to take the next step.

Can You Buy A House With Bad Credit?

It is entirely possible to buy a house with bad credit. If for nothing else, credit reports are essentially a measure to suggest how likely a borrower is to pay their debts back—not a binary indicator as to whether or not someone qualifies for a mortgage. That said, better rates and opportunities are awarded to those with higher scores.

Learning how to buy a house with bad credit starts with undersigning what your current credit score is worth in the eyes of lenders. Here’s a general scale of what borrowers can expect to receive concerning their current FICO Score:

• Less than 580: Theoretically, borrowers may qualify for a loan with a FICO score lower than 580 (all the way down to 500). However, any borrowers with a FICO score between 500 and 579 will be limited to FHA loans. Since borrowers with a score lower than 580 represent the largest risk to lenders, their loans will be required to be insured by the Federal Housing Administration. To qualify for an FHA loan, borrowers will need to put down at least 10% and pay off any unpaid collections and judgments.

• 580 – 669: Borrowers with a FICO Score between 580 and 669 may also qualify for an FHA loan, but won’t necessarily have to put as much homey down up front. In fact, borrowers in this range may qualify for an FHA loan with as little as 3.5% down. Perhaps even more importantly—for some—this is the range that qualifies borrowers for loans guaranteed by the Department of Veterans Affairs (VA loans). This is also the range borrowers may be able to apply for a conventional loan (if they meet other requirements).

• 670 – 739: Borrowers with a FICO Score between 670 and 739 may apply for conventional loans. Since they represent less risk than the previous categories, borrowers with a credit score in this area will have more options.

• 740 – 799: Borrowers who fall under this category are considered to have a very good credit score, which means lenders are more willing to extend them more credit at a better rate.

• 800 or more: Anyone with a credit score of 800 or more represents the least amount of risk to lenders. Since borrowers in the category are the most likely to pay back their debts without defaulting, lenders and banks are more willing to extend larger amounts of credit at their most competitive rates.

Home loans for bad credit holders do exist. However, the better the credit score, the more opportunities borrowers will gain access to.

How To Buy A House With Bad Credit

Buying a house with bad credit isn’t impossible. While those with lower credit scores will find their options limited, there are bad credit home loans to consider (if they meet the requirements):

• Conventional Loans

• FHA Loans

• VA Loans

• USDA Loans

• Find A Cosigner

Conventional Loans

A conventional loan is a mortgage loan that’s not backed by a government agency. Conventional loans are offered and serviced by private lenders, such as banks, credit unions, and other financial institutions. Since the government does not insure conventional loans, they’re riskier for lenders. Lenders often require stricter qualifications for conventional loans and may only offer them to borrowers with good credit and a strong financial profile.

FHA Loans

As their name suggests, FHA loans are insured by the Federal Housing Administration. The government entity began insuring loans for lenders in order to stimulate housing demand amongst borrowers with less-than-perfect credit. The FHA insures loans for borrowers with credit scores as low as 500 who can put down at least 3.5%. In doing so, lenders are able to extend their services without taking on the risk that is typically associated with lower credit scores. Of course, using a loan insured by the FHA will limit the lenders that borrowers can work with. However, it should be noted that any borrower who puts down less than 20.0% (even on FHA insured loans) will be required to pay private mortgage insurance (PMI).

VA Loans

VA loans were created specifically to help United States Veterans, Service Members, and their spouses. Aptly named, VA loans are guaranteed by the U.S. Department of Veterans Affairs and issued by select lenders. Perhaps even more importantly, qualifying borrowers may not be expected to put any money down at signing. While the VA may not require a minimum credit score, qualified lenders will typically only service veterans with a FICO Score above 620. That’s not to say no lenders will accept a lower score, but rather that anyone who does may incur additional scrutiny and lender requirements.

USDA Loans

The U.S. Department of Agriculture backs USDA loans with the intention to develop rural areas. Therefore, prospective borrowers may seek out USDa loans if they are looking in areas with a population of less than 20,000 inhabitants. Additionally, those seeking capital to settle in rural areas will also need to apply with a minimum credit score of 640 and prove that they have stable income. USDa loans are not intended to be used for investment purposes, and must be put towards a primary residence.

Find A Cosigner

In the event a borrower isn’t able to qualify for any of the previously mentioned loans on their own, there is always the option of enlisting the help of a cosigner. Since many loans place an emphasis on borrowers’ debt-to-income ratios, adding a cosigner to a specific loan can simultaneously increase the income variable and decrease the debt variable. With the right cosigner, it’s entirely possible to buy a house with bad credit and get a better rate and underwriting.

How To Fix Your Credit To Buy A House

Prospective buyers with “lower” credit scores will always have the ability to increase their prospects in the eyes of lenders. While easier said than done, here’s a few steps borrowers can take to increase their own credit scores (and chances of receiving a loan):

• Increase Your Available Credit

• Add New Accounts

• Pay Off Collections

• Avoid Hard Credit Inquiries

Increase Your Available Credit

One of the best ways to improve a credit score is to increase the amount of available credit borrowers have access to. Credit scores place an emphasis on credit utilization, which means they prefer lending to borrowers who have more available credit than the debt they incur. In other words, the more credit borrowers have available to them, the more attractive they are to lenders. Therefore, it’s always a good idea to increase the credit that’s available. Doing so may be as simple as paying down existing balances or increasing credit limits. Either way, the amount of credit being utilized will decrease and lender sentiment will increase.

Add New Accounts

Similar to the previous step, adding new accounts can decrease credit utilization. Not unlike asking for a credit increase, new accounts will improve the ratio between available credit and debt. The addition of a new account will ultimately increase the borrower’s access to credit, and improve their worthiness in the eyes of lenders. That said, borrowers who choose to add new accounts need to restrain from increasing their debts as well. It is important to note that adding new accounts will result in a hard credit inquiry, so borrowers shouldn’t look into opening more than a couple of new accounts. Opening too many accounts (or even applying to many) could set off a red flag for lenders.

Pay Off Outstanding Collections

Collections on credit reports raise significant red flags for lenders. If for nothing else, collections represent unpaid debts which borrowers have not even attempted to pay back; they are a lender’s worst nightmare. Therefore, it is in borrowers’ best interests to identify any unpaid debts on their credit reports that have been brought to collections and pay them. In doing so, get the transaction in writing and make sure the debt is deleted from any credit reports. In removing collections, borrowers may simultaneously raise their credit scores and give lenders one less reason to turn them away.

Avoid Hard Credit Inquiries

Anyone looking to improve their credit should start by not applying for too many accounts (resulting in hard credit inquiries). That’s not to say it’s a bad idea to open a couple of accounts, but rather that many more could result in too many hard credit pulls.

Otherwise known as “hard pulls” or “hard credit checks,” hard credit inquiries are the direct result of a financial institution checking someone’s credit in order to make a lending decision. More often than not, hard credit inquiries take place when prospective borrowers apply for a mortgage, loan or credit card. In doing so, the institution will typically have to authorize the pull with the client.

On the surface, a hard credit inquiry doesn’t sound too bad. In fact, a single hard pull will most likely result in a negligible impact on one’s credit score. However, several hard pulls may send up red flags. Multiple hard credit inquiries could suggest the applicant is short on cash, and needs a remedy immediately.

On the other hand, a soft inquiry occurs more often during background checks and doesn’t require permission on behalf of the borrower. Since they aren’t related to a specific application for new credit, soft credit pulls don’t impact credit scores; in other words, they don’t suggest someone is looking for more access to credit.

Should I Use A Credit Repair Company?

Credit repair services can help, but they also have a notorious reputation. They have often been accused of looking up borrowers for months or years and charging ongoing fees with little difference being made. This certainly isn’t always the case, but it can be very difficult to separate the good from the bad. In some cases, your attorney may be able to help. If it is a cut and dry case of bad items showing up that shouldn’t be there, then an attorney should be able to get them removed.

Summary

Credit scores are tools used by lenders to gauge the risk they may take on by underwriting a loan for borrowers. The lower the credit score, in fact, the more likely the lender believes the borrower will default on the loan. That said, it is entirely possible to buy a house with bad credit. While a lower credit score may increase risk for lenders, there are loan options available for under-qualified borrowers. Government-backed loans, in particular, are a great option for borrowers with less-than-ideal credit scores. Subsequently, there are steps prospective buyers can take to increase their scores. With a mind for due diligence, there’s no reason borrowers can’t increase their own scores to qualify for better loans; they just need to learn how to buy a house with bad credit and which steps get them closer to their goal.

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