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Buying a house with bad credit isn’t easy, but it’s not impossible. It all starts with knowing your options and the ways you can fix your credit.
It’s not as hard as you think to fix your credit. If you aren’t in a hurry, I recommend working on your credit first. A good credit score goes a long way.
You’ll get much better rates and terms, not to mention the greater number of options you’ll have from different mortgage lenders.
Let’s dive in and discover what lenders look for, what you can do, and how to buy a house with bad credit score if you don’t have time to fix things.
What Do Mortgage Lenders Consider a Bad Credit Score?
An online mortgage lender’s view of ‘bad credit’ and what other industries view as bad credit are two different things. That doesn’t work in your favor.
It makes sense, though.
Mortgage lenders take a large risk. They could be lending you hundreds of thousands of dollars over a 30-year term. The default risk is tremendous for mortgage lenders versus a credit card company that gives you a $1,000 credit line.
To answer the question, most mortgage lenders consider any credit score lower than 620 ‘bad.’ Now that doesn’t mean you can’t get a mortgage if you have a score lower than 620. You’ll just need government-backed home financing, aka an FHA loan.
It’s not the end of the world to get FHA financing, but know that you’ll pay mortgage insurance for the life of the loan.
At 0.85% of your loan amount annually, you could add an average of $45,000 to the loan’s cost over its lifetime (assuming you don’t refinance or sell the home sooner).
Can You Buy a House With a Bad Credit Score?
As I said above, you CAN buy a house with a bad credit score, but it will cost you in different ways.
You don’t get the best interest rates
Those rates you see advertised on TV or the bank’s website won’t be available to you. Instead, you’ll get marked up rates that account for your lower credit score and the risk it poses.
You’ll pay higher fees
Lenders have fixed fees, such as appraisal, credit report, and title fees, but they have fees they charge too. Lenders base their fees on your creditworthiness and the risk you pose. The lower your credit score is, the more they’ll charge you.
It’s called an origination fee, and lenders can charge what they want (within reason). Even 1 point on a $200,000 loan adds $2,000 to the closing costs (on top of the other expenses everyone pays).
With mortgage costs average 2% – 5% of the loan amount, you want to do whatever you can to minimize your costs.
You’ll have fewer loan options
Borrowers with ‘bad credit’ typically don’t qualify for a loan at their local bank. You’ll need an online lender or mortgage broker who works with hundreds of lenders to find someone who will accept your lower credit score.
>> More: Best Mortgage Lenders
Why Your Credit Score Matters When Buying a House
Lenders care so much about your credit score because it demonstrates your level of financial responsibility.
A low credit score usually means you defaulted on debts, paid debts late, or overextended your credit. Mortgage lenders don’t want to see any of that.
When you have a good credit score, it shows lenders that you’re financially responsible. They’re more likely to give you lower interest rates, better loan programs, and charge you fewer fees.
That being said, if you have a ‘low credit score’, and there’s a good reason for it, you may be able to explain yourself by writing a Letter of Explanation.
Tell the lender why your score fell, the circumstances behind it, and how you overcame it.
Sometimes if it’s a one-time issue that you couldn’t control, they’ll grant an exception IF you can prove you’ve overcome it.
What is the Lowest Credit Score to Buy a House?
Credit Score from 500 – 579
Your options are very limited in this credit score range. Your only option (outside of subprime loans) is an FHA loan, but with a higher down payment.
FHA loans typically require just 3.5 percent down on a home. But you need a 580+ credit score to get that. If your score is less than 580, you may still get approved with a 10 percent down payment.
Also, if you plan on using gift funds toward the loan, the FHA requires that you put at least 3.5 percent of your own funds into the transaction.
The remaining 7.5 percent can be gift funds, but only if you contribute money of your own. This gives you’ skin in the game’ and gives you more motivation to stay current on your loan.
Credit Score from 580 – 619
If you have a credit score between 580 – 619, you’re a good candidate for an FHA loan. Most lenders won’t accept rates this low for conventional financing or any other government-backed loans (VA loans need a 620 and USDA loans a 640).
With this credit score range, though, you can put down just 3.5 percent on the home.
Remember, with FHA financing, you’ll pay mortgage insurance for the life of the loan, so figure that into your budget and the bottom line when looking at the loan’s total costs.
Credit Score from 620 – 699
Once your credit score hits 620, you have more options. Some conventional lenders may give you a chance to have other ‘good’ qualifying factors, which they call compensating factors.
In other words, if you can prove you are a good risk because you qualify in other areas, they may overlook your credit score if it’s near the 620 marks versus the 699 score.
A few compensating factors include:
- A low debt-to-income ratio – This compares your monthly debts to your gross monthly income (income before taxes). Ideally, you shouldn’t have more than 36% of your income committed to debts, including the new mortgage if you want to qualify. Check our our guide on debt-to-income ratio.
- Stable income and employment – All loan programs require you to have 2-year stable employment and income history, but if you have an exceptionally long employment history or a history of rising income year after year, it could work in your favor.
- Large down payment – The more money you can put down on a home, the less risk the lender takes. If you have ‘bad credit’ it may help if you put more than the minimum required down payment.
The 700+ Club
The borrowers in the 700+ Club have the mortgage landscape at their disposal. You can qualify for just about any loan program available today, including conventional loans with the lowest interest rates and the best terms.
How to Buy a Home With Bad Credit (Step-by-Step)
If you have bad credit, it’s important to know how to buy a home with bad credit, so you don’t get taken advantage of because you’re desperate to get a house.
#1. Review Your Credit Report
Know your credit history and possibly even your score. Pull your free credit reports and review the history. See why you have the credit score you have and make a note of what you can improve. Even small changes can make a big difference in your credit score.
#2. Take Note of Negative Items or Errors
Write down all the negative items and errors you find. Make two categories – the items you can fix (mistakes on your part) and the items you should dispute (errors on the part of the creditor or credit bureau).
#3. File Disputes with all Three Credit Bureaus
Start by filing a dispute for any errors on your credit report that aren’t your fault. Write a formal dispute letter and provide evidence of why the information is inaccurate.
The credit bureaus have 30 days to respond to your dispute, so do this first as it takes the longest.
#4. Work on Rebuilding Your Credit
Fix any of the errors that were your mistakes, such as late payments or overextended credit.
Bring all late payments current, pay overextended credit card balances down, and satisfy any collections or negative debts.
In the meantime, don’t apply for new credit and don’t close any old accounts. Fix what’s bad and leave what’s good.
>> More: How to Build Credit
#5. Pay Off Your Debt
Continue to work on paying your debt down as far as you can. Remember, you want to have a debt-to-income ratio of 36 percent or less for the most favorable loan terms.
#6. Determine Your Budget
Once you’ve fixed your credit, and have things under control, determine how much you can afford.
Eventually, you’ll get pre-approved when the lender tells you what you qualify for, but that may be different from what you want to spend.
Look at your current housing payment. How comfortable are you with it? Could you afford more, or would it put you over the edge or could you go a little higher? Use this as your threshold and then stick to it.
#7. Save Up for a Down Payment
Most loans require a down payment unless you qualify for a VA or USDA loan. If you aren’t eligible for either loan, you need a down payment. Figure you’ll need at least $3,000 for every $100,000 you borrow.
#8. Consider all Loan Options
You have a variety of loan options. Here are a few:
You’ll need a 580+ credit score, 3.5% down payment, 43 percent debt-to-income ratio, stable income and employment, and proof that you’ll live in the home as your primary residence. This loan is great for first-time borrowers or borrowers with less than perfect credit. (See our list of the Best FHA Mortgage Lenders)
This is the ‘ideal’ loan since you only pay Private Mortgage Insurance if you put less than 20 percent down. You can cancel the PMI once you pay your balance down enough so that you owe less than 20 percent of the home’s value.
To qualify, you need a 660+ credit score, 36 percent debt-to-income ratio, stable income and employment, and at least a 3 percent down payment.
USDA Loans are government-backed loans for low to moderate-income families who will live within the USDA rural boundaries. This is basically areas of low population that aren’t within the metropolitan boundaries.
USDA borrowers don’t need a down payment but need a 640+ credit score and 43 percent debt-to-income ratio.
You must prove you’ll live in the home as your primary residence, that you don’t own another house, and that you don’t qualify for any other financing option (this should be your last resort).
If you are a veteran of the military or current serving (at least 181 days during peacetime) you may be eligible for a VA loan.
You don’t need perfect credit (a 620 usually suffices), and you can have a debt-to-income ratio of up to 43 percent. You must meet the VA’s disposable income guidelines for your family size and area, though. (See our guide on the Best VA Mortgage Lenders)
Consider a Credit Repair Company
If you can’t get your credit score up and you’re getting unaffordable quotes, consider a credit repair company. While they can’t fix bad credit that you did, they can dispute any errors (even the tiny ones).
They know exactly what to look for on your credit report that they can dispute to get rid of bad credit.
Even if the credit issues were your fault, if the creditor or credit bureau reported the wrong date, incorrect balance, or made any other errors, a credit repair company can dispute it for you.
>> More: Credit Saint Review
Form Good Credit Habits
No matter how you fix your credit, use the time in between to form good credit habits including:
- Pay your bills on time
- Don’t spend more than 30 percent of your credit line
- Don’t apply for new credit unless you absolutely need it
- Avoid letting anything go to collections
- Don’t close old accounts (leave old credit cards open but unused)
Bottom Line: How to Buy a House With Bad Credit
There’s a mortgage or everyone, you just have to know your options. Before you apply, maximize your qualifying factors, including your credit.
Do what you can to bring your credit score up and focus on the ‘other factors’ that offset a bad credit score and get you the loan you need.
More Credit Resources: