When you’re trying to buy a house, especially for the first time, it can feel like the deck is stacked against you.
Having bad credit can spell difficulty in getting a traditional mortgage loan. But wouldn’t getting off the rent cycle treadmill be a first step to rebuilding your finances?
What’s worse is that bad or poor credit can mean different things: a low credit score, a short credit history or a recent job change. Even open credit report disputes can make a mortgage lender say no.
But there are ways to improve your standing with lenders and realize your dream of homeownership — even with bad credit.
Why Bad Credit Is Such an Issue for Getting a Mortgage
First of all, it’s important to know what constitutes a good and bad credit score. When lenders query the credit bureaus (Equifax, TransUnion or Experian), they’re given a full credit report made up of details like your payment history, your total debt load, how much unused credit you have and more.
All of those factors comprise your credit score, which is an estimate of how likely you are to repay any new loan on time. If your credit score is low, you’re considered high risk.
Credit score ranges vary, but generally speaking there are five tiers.
- Excellent: 800 and above
- Very Good: 740-799
- Good: 670-739
- Fair: 580-669
- Poor: 580 and below
Remember that lenders are in the business of making money, and someone who defaults on a loan is a major issue for them. With a mortgage, when you’re borrowing hundreds of thousands of dollars, a high-risk borrower is an even bigger gamble.
Scores above 670 are generally considered lower risk. Anything between 580-669 is “sub-prime” – meaning a borrower can still qualify, but the terms might not be that great. Borrowers with scores below 580 might find it difficult getting credit or finding decent loan terms at all.
For a mortgage, there is no “magic number” – as lenders can always make exceptions. But a general rule of thumb is that 620 is a standard minimum for a conventional mortgage.
How to Buy a House with Bad Credit
If you’re trying to improve your odds of getting financing for a house, remember that even simple solutions can have major benefits. Here are six strategies for home buyers with less-than-optimal credit.
1. Save for a Larger Down Payment
Sometimes your credit is only part of the problem. What can make it even harder are the debt-to-income ratio rules that lenders often use.
Lenders want to see you using less than 43% of your income for all debt repayment. That includes your credit card debt and any other debts you might be carrying, so it helps to pay those off first. But what if you’re still above the 43% mark?
A simple solution is to start saving.
With a larger down payment, you’ll need to borrow less, which lowers your mortgage payments, and can give lenders more reason to look favorably on your loan.
A good place to aim for is a down payment that’s at least 20% of the purchase price of the home. Not only will this give you a better chance of getting a mortgage, but with that loan-to-value ratio, you can also avoid private mortgage insurance (PMI), further lowering your payments.
2. Borrow Privately
The people who know you best would obviously know better than a bank if you’re a good credit risk — and they may be more forgiving of an occasional late payment.
They also won’t charge you loan fees and can be more flexible about terms.
And the advantages of borrowing from family for a home go both ways. Parents or siblings might appreciate making a decent return on their money compared to what’s available from savings accounts.
Of course, that’s only if you’re extremely vigilant about your payments. No home-buying timeline is worth alienating the people closest to you. Because of that, this should be a last-resort method. Thanksgiving dinner might not taste the same when you’re sitting next to your dad while four payments behind on your loan.
At the same time, there are also seller-financing options. This might be more elusive than borrowing from family, but if you have the wherewithal to research the types of seller financing (mortgage, lease option, contract for deed, etc.), you could deal directly with the current homeowners. Keep in mind, though, that you may pay a higher price overall and even a higher interest rate.
3. Get a Co-Signer
If you’ve already approached someone close to you to help, but they’re uncomfortable actually lending you the money, there’s another option: getting them to co-sign your loan.
The primary advantage to this is that the co-signer’s income will be considered in determining how much you can borrow.
This might be exactly what you need if you have spotty work history or several late payments in your credit report that are dinging your score.
That said, having someone with good credit co-sign on your mortgage loan will not completely cancel out your bad credit, according to TheMortgageReports.com. Lenders will still consider your low credit score or other credit problems.
There’s a major downside for your co-signer as well: Being a co-signer to a loan of that size could affect their credit. In the worst case scenario, if you default on your loan and go into foreclosure, their credit will undoubtedly suffer major setbacks – and they’ll be left on the hook for your inability to pay. Another less-than-ideal situation to be in with a family member or friend.
4. Look into an FHA Loan
Most conventional home loans are held privately, by lenders like banks. The Federal Housing Administration (FHA) is a government agency that makes loans to first-time home buyers, those with poor credit or no credit and those with less savings or income.
There are several differences between a conventional loan and an FHA loan, but one of the biggest is the rules about credit. If you have a credit score over 580, you can get an FHA loan if you can make a down payment of 3.5% of the total value of the home. For a $100,000 house, that’s $3,500.
If you have a credit score under 580, you can still get an FHA loan if you can make at least a 10% down payment. That might seem like a lot of money to save up, but when compared with the difficulty of repairing your credit, it can actually be a lot easier.
And if your job history is a problem, an FHA loan might be able to help. Lenders who will issue an FHA loan look at a number of factors to determine your “probability of continued employment,” and you don’t always need the traditional two years of employment to qualify.
Going this route does mean a bit more hassle, though. FHA loans are required to have a specific kind of insurance called Mortgage Insurance Premiums (MIP), and unlike a conventional mortgage, these never expire and will have to be paid for the life of the loan. That means a higher monthly mortgage payment which can limit the amount of home you can afford.
5. Veterans: Consider a VA Loan
For veterans with lower credit scores who are ready to settle down, a Veterans Affairs (VA) loan might be a good option.
VA loans come with lower interest rates, lower closing costs, no private mortgage insurance (PMI) requirements, and you don’t need a down payment. These are private loans that are partially backed (25%) by the government.
Because of the government’s backing, banks can lower eligibility requirements. That means veterans with lower credit scores are frequently approved for more than they would be with a conventional loan.
So what’s the catch? There’s always a catch, right?
Though you won’t have to pay PMI, VA loans come with funding fees. Regular military will pay a 2.15% funding fee for 0% down, though the fee can be lowered by putting down 5% or more on the home. For those in the reserves or National Guard, the funding fee is 2.4%.
6. Other Options for Buying a House with Bad Credit
Yes, you still have a few (outside the box) options.
Buy a House for Cash
We get it, not many of us are sitting on a six-figure pile of money. With bad credit, that may be even less likely. But steering clear of banks entirely means your credit score doesn’t matter. Here’s how one couple scrimped and saved enough to pay cash for a house.
Buy a Cheap Mobile Home
Mobile homes have their advantages, including lower prices than site-built homes, which is great if you have to pay cash. Plus, if you buy a mobile home on land, you even get appreciation like you do with other homes. That said, you might think twice about a mobile home if you live in tornado-prone areas of the country.
Shop Around for Loans
Most banks either sell home loans or want the option to do so, which means meeting the requirements of the secondary mortgage market.
But some small banks and credit unions keep loans in their portfolios with more flexible qualification rules. Seek out lenders that are willing to look at your whole financial picture, rather than a bad mark or two on your credit report.
Improve Your Credit
OK, so it’s not a quick solution. But improving your credit is always a good idea, and if you can wait a few more years to buy a home, you might even be able to save up more money to afford something better.
Start by looking at how to raise your credit score. Here are 10 tried-and-true ways to build good credit.
Steve Gillman is a former contributor to The Penny Hoarder. Senior staff writer Robert Bruce contributed to this report.