The U.S. Department of Housing and Urban Development’s (HUD’s) Office of Policy Development and Research (PD&R) states that “for many Americans, owning a home is an essential part of the American dream that conveys a number of economic benefits, such as the ability to accumulate wealth and access credit by building home equity, reduce housing costs through the mortgage interest deduction, and gain long-term savings over the cost of renting.”
The search for a home can be overwhelming. Worse, having bad credit makes getting a loan very difficult and leaves many unable to fulfil that dream of owning a home. Let’s explore how to buy a house even with bad credit.
Review Your Credit Report
A FICO Score is a three-digit number based on your credit history that helps lenders determine how likely you are to repay a loan. This score affects how much you can borrow and the interest rate (or how much the loan will cost you).
You are entitled to a free copy of your credit report each year.
Go to https://www.annualcreditreport.com/ to get your report.
What’s a good credit score:
The following shows the Ratings and FICO Score Ranges
- Exceptional: 800-850
- Very good: 740-799
- Good: 670-739
- Fair: 580-669
- Poor: Under 580
People with Exceptional (800 to 850) and Very Good (740 to 799) credit score ratings will be able to get the best interest rates, while people with scores less than 670 might struggle for loan approvals. People with Good scores (670-739) might not qualify for every offer but should still find options. The minimum score that a lender accepts will vary depending on the lender. Scores less than 600 will make it more difficult to find a mortgage and if you do qualify, the loan will be more expensive than someone with a better credit score.
Lenders will consider your amount of down payment, overall debt, income, and any debts in collection when making loan determinations.
Take a look at the Loan Savings Calculator to see how a higher FICO score can save you money.
As an example, for a 30-year fixed $300,000 mortgage, here’s what the breakdown would look like based on today’s (11/5/2021) interest rates:
| FICO Score | APR | Monthly Payment | Total Interest Paid |
| 760-850 | 2.695% | $1,216 | $137,761 |
| 700-759 | 2.917% | $1,251 | $150,512 |
| 680-699 | 3.094% | $1,280 | $160,826 |
| 660-679 | 3.308% | $1,315 | $173,468 |
| 640-659 | 3.738% | $1,387 | $199,430 |
| 620-639 | 4.284% | $1,482 | $233,447 |
Compared to someone with an Exceptional credit score, a person with a Fair credit score can cost $266 more per month and $95,686 in extra total interest payments.
If you have a low score, you need to take steps to increase it.
Ways to Increase your Credit Score
Reduce “bad debt”. Your Debt-to-Income Ratio (DTI) is an important calculation for lenders to decide if you are able to take on additional debt, such as a home mortgage.
To calculate your debt-to-income ratio
Add up all your monthly bills which may include:
- Monthly rent or house payments
- Student loans, car loans, and other loans
- Credit Card monthly payments
- Other debt
Divide by the total gross monthly income (your income before taxes)
The result is your DTI. The lower the DTI, the less risky you are to lenders.
Reduce high interest debt (such as credit card debt) to improve your DTI.
Analyze your credit report and identify any mistakes.
You may be able to dispute late payments and possibly get them removed. If you have any debt in collections, see what you can to get them removed or satisfied. It might be worth it to negotiate a payoff or pay for removing any negative dings on your credit report.
Pay off more than the minimum payment amount.
When you receive your credit card bill, pay off the balance in full and on time. Do not just pay the minimum since any money owed to the credit card company accrues interest at a very high rate. If you can’t afford to pay off the entire bill in full, pay as much as you can and prioritize paying off this debt.
Increase your available credit.
You can request this increase by contacting your credit card company. Don’t increase spending if you are able to increase your credit limit. A higher credit limit can lower your overall credit utilization ratio. Credit utilization is a factor in determining your credit score. Try to keep your credit utilization below 30%.
Stop hard credit inquiries.
A hard credit inquiry or “hard pull” occurs when a person applies for a new line of credit such as a credit card or loan. This inquiry shows up on your credit report and affects your credit score. This will stay on your credit report for two years and may directly impact your credit score for up to a year.
Get authorized as an authorized user on another person’s credit card.
If you have a parent who has a good credit history and pays his or her bills on time, you might be able to boost your credit by becoming an authorized user on their account. This is especially helpful if you are just starting out. But be careful. If the primary account holder doesn’t pay their bills on time, it can hurt your credit. Make sure you choose someone you trust who also has good financial habits (pays their bills on time in full and keeps credit utilization low).
Find a co-signer for your loan.
Lenders might be open to having a co-signer for your loan if you have a low credit score. This is a significant ask for someone because if you miss a payment and/or default on the loan, both of your credit scores will suffer.
Loan Programs Available for People with Less than Stellar Credit
Conventional mortgage loans have several guidelines. These loans have stricter credit requirements than government backed loans. In most cases, you’ll need a credit score of 620+ and a debt-to-income ratio of 50% or less.
FHA loans are backed by the Federal Housing Administration and offers lower qualifying requirements such as a credit score of 580 and a minimum down payment of 3.5%. This might sound great but you need to consider the cost of the mortgage. If you put less than 10% down on an FHA loan, you’ll have to pay mortgage insurance premium (MIP) for the life of the loan, regardless of how much equity you have. You won’t have to pay mortgage insurance if you put 20% down or have 20% equity in the home.
VA loans are only available to veterans, active-duty military members and their surviving spouses. Many of the requirements are similar to a conventional loan with some added benefits. VA loans don’t require a down payment and VA loans don’t require you to pay mortgage insurance, regardless of what you put down. You can’t use a VA loan for a second home and you’ll have to pay a funding fee (certain groups such as surviving spouses and those with VA disability are exempt).
USDA loans are backed by the US Department of Agriculture and allows individuals to buy a home in a qualifying rural area with a $0 down payment and 640+ credit score.
Closing Remarks
Regardless of what loan type you pursue, create a budget and stick to it. Typically, 28% of your gross annual income should be spent on your mortgage. Banks might lend you more money but don’t stretch yourself too thin and take on a house payment that you might not be able to afford. Follow the above recommendations and you’ll see that it may be possible to buy a house with bad credit.
