It can feel like an impossible task to buy a home with bad credit, but it might not be as bad as you think. Many lenders may add additional requirements to prevent homebuyers with bad credit from buying a home but that isn’t the case for everyone.
While buying a home with bad credit is more difficult it’s not impossible and there are actually many different options available.
Can You Buy a House With Bad Credit?
The simple answer is yes. You can purchase a home with bad credit. There are three factors that lenders use to determine whether or not you can purchase a home.
The only one that’s non-negotiable is income. You must be able to repay the loan in order to get a mortgage. You need one of the other two in order to buy a home. If you have don’t have great credit, you’ll need to have assets or a down payment. If you don’t have a down payment you’ll need at least fair credit in order to buy a home.
The only exception to this is for veterans and military members who can use VA loans that work with bad credit and require no down payment.
Having funds available to use for a down payment, reserves, or closing costs is going to allow you to purchase a home even if you have less than perfect credit.
What Is Considered Bad Credit?
In order to determine what’s considered bad credit, you need to understand the different types of credit scores available to you.
There are three different credit bureaus that report credit scores:
Each of these bureaus produces a credit score based on information from your credit report. However, there are also multiple variations of your credit score within those bureaus.
With each bureau you’ll have:
- Auto Loan Score
- Credit Card Score
- Mortgage Score
- Fico 08
- Fico 09
- Whatever new score they develop after writing this
The credit bureaus are always updating their algorithms to determine how your score is calculated. However, not all lenders adapt or use these scores which is why when shopping for credit, you’ll get different scores from each lender.
The only scores that will remain the same are your mortgage scores. Every mortgage lender uses the same mortgage fico scores to determine eligibility.
There are also two different versions of scores you’ll see online
Fako scores are provided by free and cheap credit monitoring services. Websites like Credit Karma or Credit Sesame provide FAKO scores when you use them. If you are using these services they are not the same scores your lender is going to use to determine your score.
Fico scores are scores provided by the Fair Issac Corporation (FICO), and these are the only true credit scores. The only way to obtain a FICO mortgage score is by getting it from a mortgage lender or myfico.com. These are your only two options to discover what your mortgage scores are.
Now that we know what scoring model is used let’s talk about what bad credit actually looks like.
FICO Scoring Model
Fico scores range from 300 to 850. The average fico score in the United States is 716 which is considered to be a “good” credit score. Most mortgage advertisements assume you have a 740 credit score (plus 20% down) in order to get the rates advertised.
According to FICO, credit scores breakdown as follows:
- 800–850: 23% (Exceptional)
- 750–799: 23% (Very good)
- 700–749: 16% (Good or very good)
- 650–699: 12% (Fair or good)
- 600–649: 9% (Fair)
- 550–599: 7% (Poor or fair)
- 500–549: 5% (Poor)
- 499 and lower: 3% (Poor)
Each bureau (Equifax, Transunion, Experian) will report a score in this range. Any credit score under 600 is going to be considered poor or bad. Lenders will pull all three scores and use the middle credit score to qualify you. If there are multiple borrows, lenders will use the middle score of the borrower with the lowest credit score.
How to Buy a House with Bad Credit
When it comes to mortgages if you have a credit score under 640, you’ll begin to have fewer options and find fewer lenders willing to work with you. However, less doesn’t mean zero.
When it comes to buying a home with bad credit you have a few different options.
FHA Loans: FHA works with borrowers with credit scores as low as 500. If you have a score of 500-579 you’ll need to put 10% down. If you have a 580 or better you’ll need to put 3.5% down.
VA Loans: VA loans are for active duty and veterans and don’t require a down payment. VA loans are very flexible, as VA doesn’t have a minimum credit score requirement although most lenders won’t go lower than 500. Many of the big box VA lenders won’t go under 640 or 620. :
USDA Rural Development Loans: The rural development loan is also a no down payment program but many lenders require you to have a 640 credit score or higher in order to qualify. However, some lenders will allow you to get a USDA loan with a 580 credit score or higher.
What You Need to Know About Buying a House With Bad Credit
It’s possible to purchase a home with bad credit, and it often still makes sense, but there are a few things you need to know.
Bad Credit Costs More
Buying a home is going to cost you more than if you had better credit. Even borrowers with scores of 620 or higher will pay less than those under 620.
Higher Interest Rate
If you have a low credit score, you’re going to pay more in interest. The interest rate you qualify for can be as much as 1% or higher than if you had even a fair credit score between 620 and 640.
You should also be prepared to pay more in closing costs and lender fees. Low credit scores can be harder to find a par interest rate. A par rate is a rate that doesn’t cost you any additional fees called mortgage points.
When you have a low score you’ll often have to pay 1 or 2 points which is equivalent to 1% to 2% of the loan amount as a fee owed at closing.
Credit is also a factor in home insurance premiums, so clients who have past or present credit issues will also pay more for their home insurance premium than someone who doesn’t have bad credit.
Be Ready for Manual Underwriting
Manual underwriting is often needed in order to purchase a home if you have bad credit. With automated underwriting, you get an Automated Underwriting Approval from an online system. This system tells the underwriter you qualify for the loan as long as you meet certain conditions.
Manual underwriting doesn’t have an automated approval so the process will be more difficult than the standard automated approval process.
If you have to go through manual underwriting you’ll need reserves which we’ll talk about below, and be required to provide more documents.
Clients going through manual underwriting should be prepared to provide:
- An explanation for each negative credit item on their report
- Verification of Rent: Proof of on-time payment for the last 12 months
- Other items the underwriter deems necessary
You’ll Need Reserves
Reservers in the mortgage process is defined as additional funds available after you pay your closing costs and down payment. Specifically, a reserve is 1 month of your new mortgage payment.
If you have bad credit you’ll need to provide between one to three months of reserves in order to be approved.
Reserves aren’t money you actually need to spend, you just need to show it’s available. The money must be your own money so you can’t borrow it or use gift funds. Many clients who have to prove reserves will use their paychecks or retirement accounts to help.
Reserves are the biggest factor in determining if you can purchase a home with bad credit.
The Cost of Rent is 100%
While it’s definitely an even more difficult process to buy a home if you have bad credit, and are more expensive, it’s usually better than renting. Why? Because the cost of rent is 100%. You are paying your landlord’s mortgage and not building equity on your own.
When you own the home, even with a higher rate you can still build equity it just happens slower. Also, you have the option of refinancing the loan as you improve your credit.
How to Improve Your Credit Quickly
If you need to improve your credit quickly there are a few things you can do that will make a quick impact.
- Pay down credit cards: If you have credit cards with balances more than 30% of the limit, paying them down under 30% or even under 10% will make a big difference in your score.
- Get caught up on late payments: If you’re currently behind on any payments, getting caught up will stop new late payments from reporting on your credit report. This will help begin to boos your score over time.
- Open a Secure Card and Secured Loan: If you don’t have any open credit accounts, you need to start building positive payment history asap. This means you’ll likely need to get a secured account. You need both a secured credit card and a secured loan as these together make up over 50% of your credit score.
- Pay off Medical Collections: If the only collection accounts you have are medical, paying them off can also improve your score. This is because medical companies are required by law to delete the collection from your report once it’s paid.
Can I Buy a Home With No Credit Score?
Yes, you can buy a home if you have no credit score. While lenders allow it you should know that you’ll get the same interest rate and terms as someone who has a bad credit score.
Also, lenders will require alternative tradeline data. You’ll be asked to provide 12 months of on-time rent payments, and two other bills with 12 months of on-time payment history.
What’s Easiest Loan To Get With Bad Credit?
FHA loans, are the easiest mortgage loan to qualify for if you have bad credit. This is because they allow low scores and don’t require you to pay off collections.
FHA also offers surprisingly low-interest rates even for borrowers with bad credit.
If you have a low credit score and you’re not a veteran, chances are you’ll be doing an FHA loan.
How to Determine Your Next Move if You Have Bad Credit?
The best thing to do if you have bad credit is to get started working with a lender early in the process. Don’t wait until you need to purchase a home in the next 3 months to get started.
A good loan officer will review your credit report, and make suggestions on how to improve it. While it’s not uncommon to have a loan officer refer you to a credit repair company, many people can fix their credit on their own.
Repairing your credit using the tips we’ve provided will be much cheaper than paying a company to tell you the same thing.
You can also check out How to Repair Your Credit Here