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Buying a home is very possible with bad credit, but it’s harder and more expensive than it would be for people with great credit. Before you begin the home buying process, you need to ask yourself why you want to own a home. Homeownership comes with many unforeseen and significant costs that can be difficult to cover if your financial situation is unstable. Continuing to rent indefinitely or until your credit improves may be the best financial choice for you.
Key points to remember
- Try to improve your credit score as much as possible before shopping
- Consider all of the upfront and long-term costs of an FHA loan before taking out one.
- Try to improve your overall financial situation as much as possible in order to improve your chances of getting approved for a conventional loan.
FHA Loans — Your Bad Credit Loan Option
Federal Housing Administration (FHA) loans are FHA insured loans, but are actually issued by any FHA approved lender. FHA loans were created to help low and moderate income borrowers become homeowners. If individuals cannot get approved for conventional mortgages, FHA loans are the remaining option for hopeful homebuyers with bad credit.
FHA loan requirements
- Credit score as low as 500 with 10% decline or as low as 580 with 3.5% decline.
- Debt-to-income ratio of 43% or less
- Verifiable income for more than 2 years
Improve Your Credit Score
Taking a few steps to improve your credit score before making any home purchases will improve your home buying experience exponentially. In today’s buzzing real estate market, many home sellers are less likely to choose deals with low down payments that will force them through the rigorous FHA appraisal process. Improving your credit score can allow you to secure a conventional mortgage and make stronger offers on homes that are more likely to be accepted.
- Take your credit report to see why your credit is low and check for errors. This is free once a year with Experian, Equifax and TransUnion at AnnualCreditReport.com.
- Pay off all revolving lines of credit to improve your credit utilization percentage. This usually results in an immediate jump in the score.
- Get all errors removed from your credit report, especially late payments
- Consider consulting a credit repair service to see if your score can be improved enough to save you the cost of their fees in terms of reduced mortgage rates.
Why You Should Improve Your Credit Score Before You Buy
Even improving your credit score a few points before you buy can still save you thousands of dollars. If increasing your score allows you to be approved for a conventional mortgage instead of an FHA loan, you will save the initial mortgage insurance premium of 1.75% of the loan amount. Additionally, conventional loans tend to have lower closing costs and interest rates than FHA loans.
While FHA loans and conventional loans will require monthly mortgage insurance if you put less than 20%, an FHA loan includes monthly mortgage insurance for the life of the loan which you can only get rid of by refinancing and paying the fees. closing on a new loan. For a conventional mortgage loan, private mortgage insurance ends as soon as your loan balance equals 80% of the value of the property.
Optimize the rest of your borrower profile
Your credit score is not the only factor that goes into approving a loan. You can increase your chances of being approved for a loan on favorable terms even with bad credit by optimizing other parts of your borrower profile.
Putting more money on your mortgage essentially means putting more of your own collateral into the loan and the lender sees you as less likely to default and a low risk borrower. If you’re struggling to find the money for your down payment, there are many unique ways to increase your funds. Some regions even have down payment assistance programs.
Improving your debt-to-income ratio (DTI) can also help you get approved for a mortgage with bad credit. If you can pay off or get rid of some of your monthly debt, like a car loan, your DTI will improve. Increasing your income by finding a second job will also improve your DTI. The easiest way to improve your DTI is to buy homes at the lower end of your budget. If you determine that you can afford a home up to $ 300,000, but your credit score is still lower than you would like, you can increase your chances of being approved for a mortgage if you choose a home. which costs $ 250,000.
Loan options for unique populations
If you meet certain criteria, you may be eligible for a VA loan or a USDA loan. Both of these loan types allow you to put 0% down without paying private mortgage insurance and do not require a minimum credit score, making them a much cheaper option than FHA loans.
VA loans
You generally must be a veteran who served for certain periods or under specific circumstances, or be the surviving spouse of a veteran in specific circumstances. VA loans are issued by private lenders but backed by the VA. You must have a certificate of eligibility from the VA to get a VA loan.
USDA loans
These loans are typically made in areas designated as rural by the USDA, and borrowers must meet income eligibility limits based on their county’s median income and household size.
Is it harder to get a mortgage with bad credit?
Yes. Bad credit makes it harder to get a mortgage. Fewer lenders offer FHA loans than conventional lenders.
Can I get a conventional mortgage if I don’t have a 20% down payment?
Yes. You can get a conventional mortgage with as little as 3% down, as long as you meet the lender’s other credit rating, income history, and debt-to-income ratio requirements.
Do I have to pay for credit repair before shopping at home?
Try to get an estimate from the credit repair service of how many points they can improve your score and how much their service will cost in total. If they can improve your score enough to qualify for a non-FHA mortgage, you’ll save 1.75% on initial mortgage insurance premiums ($ 1,750 per $ 100,000 of home), which will likely offset the cost. of credit repair service. You may be able to improve your credit score on your own, so do your due diligence.
The bottom line
While it is possible to buy a home with bad credit, it might not be the best choice. FHA loans are a great tool for borrowers, but changes to the program after the subprime mortgage crisis make it a very expensive loan product. Prospective borrowers should do some math to see how improving their credit and having more money to put aside could save them before rushing through the home buying process. .