Just five years ago, new mortgages were hard to come by. With record defaults pushing banks to the brink of collapse, lenders were only giving new loans to the very best borrowers with the very best credit scores. Now the tides have turned and banks are lending money more freely again. If you got stung with bad credit due to a past mistake, you may still be able to buy a home today. Read on to learn more about how to buy a house with bad credit.
Understand Your Credit
In an ideal world, everyone would have a 20% down payment, low debt, a stable work history, and excellent credit. If you happen to meet that criteria, finding a new mortgage isn’t very difficult. We all know that everyone doesn’t have perfect credit. If you are looking to take advantage of low housing prices and interest rates, but don’t have excellent credit, you are going to have a different experience.
Bad credit is a big barrier to finding a home purchase loan. There is no denying that there are fewer mortgages for bad credit borrowers. But, if you know where to look, you may still be able to buy a house with bad credit.
Government guaranteed loan programs are your best options for buying a house with bad credit. This does not mean taking a loan out from the government. Instead, you work with regular mortgage lenders who also offer loans for which the government guarantees payment, in case you default.
FHA loans are the most popular government mortgage loans for purchasing a home. FHA loans offer a few distinct advantages:
- Lower Credit Score Requirements– You can get an FHA loan when your credit score would not qualify you for any other kind of loan. FHA loans are technically available, according to FHA regulations, even if your score is as low as 500. However, FHA lenders require higher credit scores than 500. If you shop aggressively, you can find an FHA loan with a credit score of 580. This is far lower than the standard credit scores required by conventional lenders.
- Qualify with Limited Credit History– You don’t need an extensive credit history to get an FHA loan. Usually, an FHA loan requires you to have two active accounts in good standing on your credit report. But, there are exceptions. If you lack credit accounts, you may be able to qualify if you can prove a solid payment history on house rent, auto insurance, and utilities.
- Easier to Qualify with a Past Bankruptcy– You can get an FHA loan after your Chapter 7 bankruptcy has been discharged for 24 months. For a Chapter 13 bankruptcy, it is even possible to qualify for an FHA loan when you’re in the middle of your Chapter 13.
- Relaxed Foreclosure Rules– You can qualify for an FHA loan if you have had a foreclosure or short sale more than three years ago. For a conventional loan, you have to wait seven years.
- Rate Not as Dependent on Credit Score– The interest rate you get on an FHA loan or conventional loan is tied to your credit score. The lower your score, the higher your rate. However, your rate is hiked more in a conventional loan than an FHA loan, for less than excellent credit. Also, many conventional lenders won’t even work with borrowers who have less than excellent. As an example, a borrower with a 620 credit score could expect to pay an extra 1% for an FHA loan and as much as 2% higher on a conventional loan. Bad credit loans are never an option for a conventional loan.
- Low Down-Payment– Credit is not the only barrier to qualifying for a conventional loan. Lack of a big enough down-payment that’s needed for a conventional loan is a huge barrier to many borrowers. You can buy a house with an FHA loan with less than a 3% down payment. Conventional loans standardly require 20% down! The days of getting 100% financing, by combining first and second loans, are long gone.
VA loans are available only to borrowers who obtain a Certificate of Eligibility from the VA. You can read the full eligibility requirements at the VA Web site. Note that these loans are for military veterans only.
VA loans offer many of the same benefits of FHA loans, but they are not the same. For instance, VA loans have stricter credit score requirements. VA lenders require a minimum credit score of 620.
VA loans are available at 0% down! VA loans also often have the lowest rates available for any home loan. VA loans do not require mortgage insurance, which further reduces your costs.
If you are eligible for a VA loan, make it the first option you investigate.
Improve Your Credit
When you have bad credit, you have limited financing options for buying a house. FHA loans are the best bad credit mortgage options, but remember that they come with extra expense, due to the FHA requirement for both upfront and annual mortgage insurance. If your credit score is the only thing that disqualifies you for a conventional loan, find out from your loan officer how much you need to improve your score to get a conventional loan. It may be cheaper to delay your home purchase, if you can improve your score in a couple of months, so it is high enough to get a conventional loan.
Whenever your credit score needs improvement, make sure to take the proper steps to build your score. You only improve your chances for buying a home, when you raise your credit score.
Credit is not the only requirement for a home purchase. Whether your loan is conventional, FHA, or VA, you have to meet lender debt-to-income requirements. Having a lot of debt can keep you from qualifying, even if your credit score meets the requirements.
First published June 27, 2012. Updated July 21, 2014.
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