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If you know your credit is on shaky ground and you're starting to think about buying your first house, you may be nervous about your chances. First, some good news: You may be able to get a home loan with bad credit. However, as you might have already guessed, having a poor credit history can make the process trickier and more expensive.
If you're not in a rush, you could be better off focusing on improving your credit before buying a house. But if you need to move and renting isn't an option, you'll want to learn about the different programs available to borrowers with low credit scores.
Check Your Credit Reports and Scores
Checking your credit reports and scores early in your house hunt can give you a sense of which home loans are realistic options.
What qualifies as a good or bad credit score can vary depending on the lender and the type of credit score (there are many different credit scores). However, most mortgage lenders will review your credit reports from Experian, TransUnion and Equifax, as well as FICO® Scores* based on each report. They typically use the middle score to help determine whether you get approved and to set your interest rate and repayment terms.
FICO® Scores range from 300 to 850, which are then divided into five score ranges:
- Very Poor: 300 - 579
- Fair: 580 - 669
- Good: 670 - 739
- Very Good: 740 - 799
- Exceptional: 800 - 850
The higher your score, the more options you'll have for credit, including home loans.
If your middle score is below 500, you might not be able to get approved for a home loan and may have to focus on building your credit first.
With a middle score of at least 500, a government-backed FHA loan could be an option if you can afford a 10% down payment. There are also government-backed mortgages with middle-score requirements of 580, 620 or 640 and lower down payments.
Once your credit score is in the mid-600s, you may start qualifying for non-government conventional mortgages directly from mortgage lenders.
Getting a Home Loan With Bad Credit
Unfortunately, getting approved and getting a good interest rate aren't the same thing.
The low mortgage rates that you see advertised are generally reserved for borrowers who have very good or exceptional credit scores. Having a low score often means you're stuck with a much higher rate.
Because mortgages are often very large loans that take decades to repay, even a 1% or 2% increase could lead to paying tens of thousands more in interest over the lifetime of your loan. So no matter what your credit scores, you'll want to compare your loan options to get as low a rate as possible. The Consumer Financial Protection Bureau (CFPB) has a mortgage interest rate tool you can use to compare rates based on your state, credit score range and loan details. Government-backed mortgages, such as FHA and VA loans, are often a good starting point if you have poor credit.
FHA Home Loans
The Federal Housing Administration (FHA), part of the U.S. Department of Housing and Urban Development (HUD), has a home loan program that can help consumers with poor credit. Under the program, the FHA won't actually lend you the money. Instead, it insures home loans, meaning the FHA will repay the lender if a borrower defaults on a mortgage. The lenders can therefore be more lenient about credit and income requirements.
Lenders need to follow the FHA's guidelines and requirements, though. To qualify for an FHA loan, you'll need:
- Proof of employment.
- A middle credit score of 580 with a 3.5% down payment, or 500 with a 10% down payment.
- Generally, your monthly debt payments can't be more than 43% of your monthly gross income (income before taxes), or 31% after including your mortgage and other home-related expenses, such as property taxes.
There are other requirements as well. For example, FHA loans have a maximum loan amount, which varies depending on where you're buying a home.
In general, FHA loans might be more expensive than conventional loans for buyers with good credit or who can afford at least a 10% down payment. However, the FHA route could be the better option if you have poor credit or can only afford a small down payment.
If you're a service member, veteran or surviving spouse and meet the eligibility requirements, you may qualify for the U.S. Department of Veteran Affairs (VA) home loan program.
The VA backs loans, which is similar to the FHA program in that the VA insures the loan, but a VA-approved lender issues the loan. There are also VA direct loans, where the VA is the lender, available if either you or your spouse is Native American.
Technically, there's no credit score requirement for VA-backed loans. However, many VA-approved lenders require a minimum credit score of around 620. This requirement is still below the common conventional loan requirement of 660, but it's above the cutoff for some FHA loans.
There are important differences to consider if you're eligible for both an FHA and a VA loan. For instance, VA loans might not require a down payment or monthly mortgage insurance, but they could have a higher upfront fee. If you think you'll be moving again soon, it might make more sense to go with whichever loan has the lower upfront fee.
Of course, you'll also want to compare the interest rates and monthly payments on the loans to see which option best fits your budget.
Savings for First-Time Home Buyers With Bad Credit
If you have poor credit and are a first-time home buyer, you might also qualify for assistance programs. And don't let the title throw you off: The definition of "first time" varies. Even if you've bought a home before, you may still qualify as long as it's been several years since you last owned a home.
Local and state governments, along with nonprofit organizations, often run these assistance programs. The requirements can vary, but may include buying a home in a specific area, having a low or medium income, or working as a public service employee, such as a teacher or law enforcement officer.
The benefits also vary among first-time homebuyer programs. The programs might:
- Help you get a lower interest rate on your mortgage.
- Cover part of your down payment or closing costs.
- Offer you a no-interest loan to pay for your down payment or closing costs.
To find first-time buyer programs in your area:
- Look on your state's Housing Finance department website. Here's a directory of the states' websites.
- Go to the HUD page for your state and review the local resources and homeownership counseling options.
- Search the Down Payment Resource directory.
- Search "first-time homebuyer programs" online. Include the name of your state or county for more localized results.
Mortgage Lenders Consider More Than Credit Scores
While your credit can be an important factor in determining whether you can get approved for a mortgage, it's not the only factor. In some cases, you may be able to make up for having low credit scores if you have an otherwise good financial situation.
Here are some examples:
- A large down payment could make it easier to qualify for a home loan and help you get a lower interest rate.
- Your debt-to-income (DTI) ratio can be an important factor. A lower DTI is better when you're applying for a home loan.
- Adding a creditworthy cosigner to your application can also help. However, the cosigner will be legally responsible for the mortgage payments, and the mortgage could impact their creditworthiness and increase their DTI ratio.
- Having few or no debts could ease lenders' concern about your ability to manage bills.
- If your mortgage payments are similar to your rent payments, lenders may appreciate that your monthly payments will stay steady.
- A large savings balance could show lenders that you'll be able to afford your mortgage payments even if you're faced with unexpected bills or lose your job.
- A long work history with your current employer, or in your field, may demonstrate that you'll be able to move up in your industry or quickly find another job.
Remember, credit scores attempt to predict the likelihood that someone won't be able to repay a debt on time in the future. So, whether it's your cash savings or employment record, showing your financial stability and ability to cover future bills could help your application.
How to Improve Your Credit Scores Before Buying a Home
Even if you really want to buy a home right away, it might make more sense to work on your credit first. Particularly if you're already struggling with bills, taking on a new, large financial commitment could stretch you beyond your means.
There are many ways to improve your credit scores. Here are a few tips :
- Continue making on-time payments. Making credit card and loan payments on time is one of the best ways to improve your scores. Even if you can only afford minimum payments, that's better than missing a payment altogether.
- Pay down revolving debt. Your credit utilization rate is the percentage of your available revolving credit that you're using, and it's an important factor in determining your credit scores. Paying down your revolving debt, such as credit cards and lines of credit, can help lower your utilization rate and increase your scores.
- Keep your credit cards open. You could cut up a credit card or lock it away somewhere if you don't want to be tempted to use it. However, closing a credit card account will lower how much available credit you have and could increase your utilization rate.
- Build your credit file. If you have fewer than five open accounts or no recent activity on on your credit report, you may have a "thin file," which can make getting approved for new credit accounts difficult. You may want to use your credit card accounts to add recent activity to your credit reports. Or, if you don't have any accounts, trying opening a secured credit card, use it to make a small purchase each month, and pay your bill in full by the due date to build a positive credit history.
- Time your applications. Applying for new loans or credit cards can also lead to a hard inquiry, which can hurt your scores. Hard inquiries stay on your credit report for two years, but generally, their impact on your scores only lasts a year or less. It may be best not to apply for any new accounts once you're several months away from applying for home loans.
- Think twice before filing a dispute right before applying for a home loan. An error on your credit report, such as a late payment that you're certain you paid on time, could be hurting your scores. Disputing the error and having it removed or corrected could improve your scores. However, the process could take 30 to 45 days, and you might have trouble getting approved for a mortgage while there's a pending dispute on your credit report. If possible, check your report for problems several months before you plan to apply for a home loan.
If you have bad credit but aren't at the very bottom of the score range, you may still be able to qualify for a home loan, but you likely won't get a great rate. Consider your mortgage options and look for loan assistance programs to help you get as good of a deal as possible. However, if you're able to put off the purchase while you work to improve your credit scores, that could save you a significant amount of money over time.
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