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Buying a House with Bad Credit: A Guide to Your Home Loan Options

Buying a House with Bad Credit: A Guide to Your Home Loan Options

October 15, 2021 by X2 Mortgage

Buying a house can be a major decision. Whether you're a first-time home buyer or a seasoned homeowner, the biggest component when purchasing, is always how to finance it. 

If you're thinking about buying a house with bad credit, you're not alone. Many people are interested in the idea of owning a home, but they're fearful that they won't be able to do so because of their credit score. 

However, owning a house with bad credit isn't as tricky as it sounds as long as you understand your options and take advantage of any available opportunities to improve your score.

There are loan options available to assist homebuyers in qualifying for a mortgage. So let's walk you through what you'll need to accomplish buying a house with bad credit.


What does a low credit score mean to mortgage companies?

A "bad" credit score to mortgage lenders is any score that falls below 620. Bad credit scores will affect your ability to secure a mortgage and the rate and terms you will be offered for your mortgage. Look at the ranges below to see where you fall:

  • Poor credit is less than 640: Consumers with credit ratings in this range are considered high risk by lenders. If you have poor credit, you may be unable to obtain a conventional mortgage, but you may qualify for a government-backed home loan.

  • Fair, which ranges from 640 to 699: Creditors consider customers with credit scores in this range to be less hazardous. You may have less debt or better payment history than low-credit borrowers. You can also get a traditional mortgage with fair credit. Still, you'll need to be stronger in other areas to compensate, and you'll likely pay a higher interest rate.

  • Good credit ranges from 700 to 749: You'll have an easier time securing a mortgage and getting a cheap interest rate if you have good credit. More than one lender is likely to make you an offer.

  • An outstanding credit score that is 750 or higher: Reflects your capacity to manage debt. You consistently make on-time payments and don't take up too much of your credit limit. With a stable income, you'll be able to qualify for a house mortgage from various lenders and have the freedom to choose the least expensive alternatives.


What is the Minimum Credit Score Required to Buy a Home?

Your credit score is a number between 300 and 850 that lenders use to evaluate your creditworthiness. Several factors can determine it, and the requirements differ for conventional and government-backed loans.

The minimum credit score required depends on your income and the mortgage lender but generally, to purchase a house, you would need a minimum credit score of 580. 

In some situations, you can push that score all the way down to the 500 mark as long as there's compensating factors to offset the added risk of the lower credit score.


Is it Advantageous to Get a Mortgage with Bad Credit?

Buying a home, particularly with bad credit, is a risky venture that few would consider. Many people think that owning a home is a badge of honor and that buying a home with bad credit will result in an automatic upgrade to good credit. 

Maybe this is true, but tough times come, and tough times go, and it's possible that your credit rating will never climb higher. So how do you know if buying a house with bad credit is right for you?

With bad credit, you may be able to get a mortgage, but you will likely pay higher interest rates and may be forced to put down a larger down payment. The important thing is to remember that you should only take out a mortgage if you can afford the monthly payments. If you can't keep up with them, you risk losing your home.


Home Loan Options for Buyers With Bad Credit

  • Conventional Loans

While Conventional loans aren't the most popular option for individuals with bad credit, they are the most frequently used method of obtaining a mortgage out of the bunch. The majority of borrowers with bad credit will not be able to qualify with a Conventional loan unless there are some compensating factors like a large down payment, high income, low debt, etc.

Many conventional loans do, however, come with a particular set of terms and conditions and fees that can either reduce or increase the amount you borrow.

  • FHA Loans

The Federal Housing Administration (FHA) is a government agency that insures mortgages issued by private lenders and guarantees the mortgages of home buyers and homeowners who cannot obtain a mortgage through their bank. 

They are intended to provide more homeownership opportunities to individuals who might not be able to qualify with a Conventional loan. They can be a great way to purchase a home without sinking tons of money into a down payment, and more importantly, without having the best credit score.

You can use FHA loans to buy a home with a relatively low monthly payment, but they require that you meet the minimum credit score requirements of 580. However, If you can put down a 10% down, you may be able to get approved with a credit score of 500 to 579 with additional compensating factors.

FHA loans are the most popular method in buying a home with bad credit.

  • VA Loans

VA loans are home loans backed by the Department of Veteran Affairs (VA) to support veterans or active-duty service members.

Good news is that VA home loans follow similar guidelines to FHA in regards to having easier qualifying metrics in relation to Conventional loans. While there is no minimum credit score to be eligible for a VA loan, it is recommended that you have about a 580 credit score. Reason being is because lenders are required to run something called "Automated Underwriting System" which determines the risk tolerance allowed. It's much harder to obtain an approval with this if the credit score is under 580. 

Same rules apply as with FHA loans though, compensating factors allow for lower credit scores and overall loan approval is determined on a case by case basis.

  • USDA Loans

Let's face it, people with bad credit can't get a regular bank loan. But you can get a USDA loan! These loans are a special type of loan specifically tailored for people with bad credit and who own a home in a USDA eligible location.

A USDA loan is a government-backed loan backed by the United States Department of Agriculture with the goal of making sure borrowers can buy a house at a reasonable price and get a mortgage that fits their lifestyle.

The three government-sponsored loans offered by the USDA are meant for people who have trouble paying for housing, have no or limited credit history, or are not sure which loan is best for them.

With this loan, you can buy a home in a qualifying rural region with no down payment.

To meet the criteria for a USDA loan, most lenders will require at least a 640 credit score and other income requirements specific to USDA loans.


Guide to Buying A House With Bad Credit

Unlike traditional mortgages, which require a decent credit score to qualify, loans for people with poor credit often have higher mortgage rates. However, if homeownership is your aim, you can surely attain it quickly. Here are some tips for buying a house with bad credit.: 

Step 1: Find out your credit score.

It's no secret that lenders like to see people who are responsible with their money. Your credit score is a number that represents your creditworthiness. The higher the score, the more confident the lenders are.

Take a peek at your credit report as soon as possible. Your credit score is available for free from various sources, including some banks and credit card firms. Those will give you a decent idea of where your score is at, but it's not exact and here's why. Instead, it's recommended that you get an exact FICO breakdown with a monitoring service if you're serious about buying a home.

Keep in mind that you have three credit scores from each major credit reporting agency: Equifax, Experian, and TransUnion. Finding out all three (which is your FICO) is an excellent idea. 

Step 2: Check for errors on your credit report.

Your credit profile can affect you from buying that house you always dreamed of. And, as with any other financial tool, errors can happen. If you're struggling to get a loan or you're getting hit with a higher interest rate because of a mistake on your credit report, things will get worse if you don't fix it. 

Any errors could result in a lower score. If you feel your credit report has been compromised, you should request a free credit report from the three major credit agencies which is allowed by federal law once a year.

Keeping track of your credit score and checking for errors on a regular basis is an excellent method to make sure you're in the best possible position. You can then weigh your alternatives for a traditional or government-backed loan and apply for a mortgage when you're ready.

Step 3: Consult a mortgage loan officer.

Getting a mortgage can seem like a daunting task, especially for those where banks or other lenders have turned down in the past. But it doesn't have to be. A mortgage loan officer is a knowledgeable, experienced specialist who can help you better understand your options, avoid foreclosure, acquire a home, preserve your credit, and address other concerns. 

Consulting with a qualified mortgage consultant will help you better understand several aspects of the home-buying process, such as financing possibilities and how to close on a house, as well as how your credit score will affect the process. They will help you calculate the pros and cons of getting a mortgage at this time in your life.

Step 4: Be willing to pay higher mortgage interest.

If you're ready to pay higher interest rates, you can still get a mortgage with a bad credit score. Lenders are aware that applicants with poor credit histories have a habit of paying bills late or not at all. To protect themselves, they charge credit-challenged applicants higher interest rates. A higher interest rate implies a larger monthly payment on your mortgage. 

Step 5: Pay off your other debt.

Identify any outstanding debt you owe and pay it down until it's paid in whole. This is one of the best strategies to improve your credit score and is beneficial for several reasons. First, if your overall debt obligations decrease, you have more room to take on more loans, making you less dangerous in the eyes of your lender.

Your debt to income ratio is one of the most important factors that lenders consider. It's the amount of required obligations you have each month in comparison to your income. The ratio is simple: 

(Monthly Payments + Expected New Mortgage Payment) ÷ Monthly Income

Depending on the loan program, lenders will require this ratio to be under a range between 43% to 60%. 

Step 6: Review your housing budget.

Buying a house is a significant investment, and it should not be one you make without a budget plan. It can be tough to know exactly how much you can afford when you're in the market. First, you need to know how much you'll need for your down payment. This is when a mortgage loan officer will be a great help to you.

Each loan program requires a different minimum down payment. For example, FHA loans generally require a 3.5% down payment while Conventional ranges from 3% - 5%. There are even down payment assistance programs to completely eliminate the need for one at all. Keep in mind that these come at very high interest rates and very unfavorable loan terms. 

Step 7: Save up for a larger down payment.

If you can come up with a more significant down payment, lenders might be ready to take a chance on you.

While there are minimum down payments required, larger down payments can be the difference between a loan approval or not with bad credit. The reasoning is similar to why bad-credit consumers are charged higher interest rates. When you put down more money in advance, there's less risk involved for the lender as you'll have more skin in the game in case of a foreclosure.

Step 8: Improve your credit score.

This is imperative. After you've reviewed your credit report in great detail, you'll know what has been working in your favor (credit score) and what has been working against you. It's time to clean that report up and get your credit score moving in the right direction.

There's plenty of great resources to learn how to quickly improve your credit score. If you don't have the time to do it yourself, then feel free to reach out to a trusted and well-known credit repair company like MyCreditGuy.

If you want to apply for larger loans, qualify for the most acceptable rewards cards, or get better interest rates, you'll need to improve your credit score. Keep in mind that apparent improvements in your credit score may take a few weeks or even months.


Wrap up

In summary, if you have bad credit but are ready to take the next step in buying your first home, you have several options, and it is possible. The key is to work with a lender, like X2 Mortgage, who specializes in lending to people with bad credit. If you put down a sizable cash deposit, most lenders will be willing to overlook any credit issues.

However, it's essential to understand the options for buying a home with bad credit. Don't endeavor to do anything on your own. In fact, its recommended you seek the help to make sure you can get the mortgage that fits your needs.

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