Many people with bad credit assume that homeownership isn’t an option. However, you’re not destined to rent for the rest of your life. Buying a house with bad credit is possible with the right approach. Below are some tips to help make it happen.
Why is credit important when buying a house?
Credit is just one factor involved in buying a house, but it’s an important one. Credit shows lenders your trustworthiness. Mortgage lenders want to ensure that you are a responsible borrower, as they’re giving you hundreds of thousands of dollars to purchase a home.
Lenders want to ensure that they will get their money back within the agreed-upon period with the accrued interest. All lenders are risk-averse and only want to provide financing to qualified borrowers.
Mortgage lenders use your credit history to determine how much you’re eligible to borrow and your interest rate. While most lenders have a minimum credit score, you can expect to pay more interest if your score is close to the minimum rather than substantially above it.
What is considered "bad" credit
The term “bad” credit is a subjective term.
Here is a breakdown of different credit score meanings when you’re trying to buy a house, car, or open a new credit card. This breakdown is according to Experian, one of the three major credit bureaus alongside TransUnion and Equifax:
- A poor FICO score is between 300 and 579 — 16% of consumers fall into this category.
- A fair FICO score is between 580 and 669 — 17% of consumers fall into this category.
- A good FICO score is between 670 and 739 — 21% of consumers fall into this category.
- A very good FICO score is between 740 and 799 — 25% of consumers fall into this category.
- An exceptional FICO score is between 800 and 850 — 21% of consumers fall into this category.
In this case, “bad credit” can be equated to “poor credit.” This means a credit score below 579 can make it difficult for you to buy a house.
What credit score do you need to buy a house?
There’s no set minimum credit score requirement for buying a house because lenders and loan products often set their own requirements.
However, it would be very difficult for you to buy a home with a credit score that’s “bad” or below 580 — difficult, but not impossible! If your credit score is above 500, but below 580, you may be eligible for a Federal Housing Administration (FHA) loan. Still, FHA loans and VA loans prefer a credit score above 580.
If you’re looking for a conventional loan, you need a credit score above 620 to qualify. Keep in mind that lenders can set requirements above these base numbers, which is why it’s important to shop around and find a lender that works for your financial situation.
Tips for buying a house with bad credit
If you have bad credit and worry that this will derail your dream of buying a house, there are still ways to make your dream a reality.
Tip 1: Examine your credit report
First, you need to look at your credit report. Even if you know that your credit score will be low, knowing the exact number can help you determine which loans and lenders may be able to help.
Examining your credit report also allows you to dispute any inaccuracies that could affect your score.
Tip 2: Find the right type of loan
Once you know your credit score, you need to find the right type of loan. Although you may not get a conventional mortgage loan with a bad credit score, you may qualify for federally-backed loans, including FHA, VA, and USDA loans.
Tip 3: Have a larger down payment
If you’re still having trouble qualifying for a mortgage loan due to bad credit, there are ways to decrease the risk you present to lenders.
One of the best options is presenting a larger down payment. For instance, those with credit scores between 500 and 580 may be eligible for an FHA loan if they can put 10% down. In contrast, people with credit scores above 580 only have to put 3.5% down for an FHA loan.
Tip 4: Pay a higher interest rate
If you have bad credit, you may need to pay a higher interest rate. Lenders charge interest rates based on the risk you present. Because people with lower scores present a higher risk, brokers will charge a higher mortgage rate with higher mortgage payments.
Higher rates often come as a surprise to first-time home buyers and can have a substantial impact on how much money they’re able to borrow. Be prepared to pay higher rates when looking for a home that meets your needs.
Tip 5: Improve your credit score
Finally, the last and most obvious way to buy a house with a bad credit score is to improve your credit score.
While this is easier said than done, it is possible. Here are some ways you can improve your credit score and qualify for better mortgage terms:
- Make consistent on-time payments: Pay your credit cards and loans before their due dates.
- Pay more than the minimum: Try paying more than the minimum amount to pay debts faster and boost your score. A good strategy involves making payments twice a month rather than once a month. Another strategy involves putting any leftover money towards payments at the end of the month.
- Avoid hard credit inquiries: Avoid applying for other loans and new credit cards when you’re trying to build your credit score. Too many “hard” inquiries can negatively impact your score.
- Increase your credit limits: Increase your credit limit without applying for new cards to help your credit utilization ratio.
- Keep existing accounts open: Even if you pay off a credit card, keep the account open to continue to benefit your credit score. The length of your oldest open account will impact your score.
It is possible to buy a house with bad credit
With the right approach, it’s possible to buy a house with bad credit. For more insights into lending and home buying, check out Vaster Capital’s online resources.
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