Intro: Guide to Buying a Home with Poor Credit
Often referred to as the American dream, achieving homeownership is important to many people. Obtaining a mortgage can be a lengthy process and can be seen as scary – especially to those with less than perfect credit.
Many people believe that it is impossible to buy a home with bad credit, but this is not necessarily true.
While getting a home loan with bad credit may not be as easy as it would be if you had great credit, it can be done in many cases. In this article, we will cover what you need to know about buying a home with bad credit.
What Is Considered a Bad Credit Score
When considering what it will take to get a home loan with bad credit, it is important to understand where your credit score currently stands. Your credit score is a number generated by factors contained in your credit report.
A credit score is used by lenders to determine your financial risk, and it can affect whether you are approved or denied for a loan and how high or low your interest rate will be.
Ninety percent of lenders use a type of credit score known as a FICO score to determine if a consumer is creditworthy or not. FICO scores range anywhere from 300 to 850, with the higher numbers being considered the most creditworthy and the lower numbers being considered the biggest financial risk.
The range of FICO scores generally falls into these categories:
- 300 – 629 is considered a bad credit score
- 630 – 689 is considered a fair credit score
- 690 – 719 is considered a good credit score
- 720 – 850 is considered an excellent credit score
The average credit score of Americans was 695 as of April 2015, meaning that the majority of Americans are considered to have good credit.
Can You Get a Mortgage with Bad Credit?
If your credit score is in the “bad credit score” range, all hope is not lost. If your score is closer to the 400 or 500 range, then you may find it extremely hard to buy a home with bad credit. However, if your score is close to 600, your odds of buying a home with bad credit are much better.
Image Source: Buying a Home with Poor Credit
When it comes to getting a home loan with bad credit, where your credit score falls in the bad score range makes all the difference.
Someone with a score of 450 will need to do some work to improve their score before being able to get approved for a mortgage, but someone with a score of 600 will have home loan options available to them.
Types of Mortgages and Minimum Score Requirements
There are many different types of mortgage programs available, and each has a different minimum credit score requirement in order to qualify.
When asking, “Can you buy a house with bad credit?” knowing the minimum score requirements will help you decide if your score is where it needs to be to get you qualified.
For those interested in getting a home loan with bad credit, an FHA loan is probably the best route to take. FHA loans are backed by the government, and the requirements for FHA loans are set in place by federal law. There are two separate credit thresholds set forth for FHA loans.
The first threshold is for people with credit scores between 500 and 579. Applicants who fall within this range can be approved to buy a home with bad credit but must have at least ten percent of the purchase price available as a down payment.
The second threshold is for applicants with credit scores of 580 and higher. Applicants who fall into this range only need a minimum of three and a half percent of the purchase price as a down payment in order to qualify.
To utilize an FHA loan to get a home loan with bad credit, potential borrowers must meet additional requirements along with the minimum credit score and down payment amount needed.
These requirements include:
- A debt-to-income ratio of 43% or less with the proposed mortgage payment
- No bankruptcy discharged in the last 24 months
- Steady work history or the same employer for the past two years
- The loan must be used to purchase a primary residence
- Total monthly mortgage payment (including homeowner’s insurance, taxes, mortgage insurance, etc.) must be 31% or less of borrower’s gross income
- No foreclosures within the last 36 months
- The property being purchased must meet FHA safety requirements
If you have a bankruptcy or foreclosure in your past, you need to have a perfect payment history since the time of the incident.
Buying a home with bad credit is possible with an FHA loan, even after bankruptcy or a foreclosure, but you must be able to show that you have learned from the incident and kept a good payment history since.
Because of its more lenient credit requirements and low down payment option, an FHA loan is the typical route used by those who hope to get a home loan with bad credit.
VA loans are government-backed loans that are available to current and past members of the military. These loans are available for service members to be able to purchase a primary residence and are a good choice for military veterans who want to look into buying a home with bad credit.
Lenders of VA loans are left to determine the minimum score requirements for these loans, and most of them require a score of 620 or higher to qualify. The largest perk of this type of loan is that it allows borrowers to finance 100% of the purchase price of the home, with no down payment required.
This type of loan can help some people with less than stellar credit, but because VA loans are only available to those associated with the military, it is not an option that everyone looking to buy a home with bad credit will be able to take advantage of.
Another option for buying a home with bad credit is a USDA loan. This type of loan is a government-backed loan designed to help low- to moderate-income families purchase homes in rural areas. In order to take advantage of this type of loan, your income must be at or below a certain level as determined by the USDA for your specific area.
USDA loans are ideal for many low- to average-income buyers who are looking to get a home loan with bad credit because it provides 100% financing with no down payment required. There is a requirement that the home being purchased must be located in what the USDA considers to be a rural area, but 97% of areas in the United States are eligible under the USDA’s rules, leaving only 3% of the country ineligible.
USDA loans do not have a minimum credit score requirement, but a potential borrower must be able to show a good credit history for the previous 12 months. This means there should be no late payments, collection efforts, or judgments on your credit report within the past year. Larger infractions such as bankruptcies and foreclosures will need to be even further in the past with a perfect payment record since.
Improving Your Credit Score
If your credit score is below 580 or you have numerous delinquent payments in your recent credit history doesn’t mean you will never be able to buy a home – but it may mean you can’t buy a home right now. There are ways to improve your score rather quickly to get you on the road to being able to buy a home with bad credit.
Image Source: Guide to Buy a House with Bad Credit
The best way to improve your score is by being diligent about making all of your payments on time. A year of perfect payment history will go a long way in proving to lenders that you are ready for the responsibility of home ownership and allowing you to buy a home with bad credit. You can use the time to save up for a down payment and closing costs.
You should also pull your credit report and check for any discrepancies. You can get a free copy of your credit report from each of the three bureaus once a year by visiting annualcreditreport.com. You should dispute anything that you feel does not belong or is not accurate to the bureau that reported it and request that it be removed.
Another key to getting a home loan with bad credit is to use your credit sparingly, paying off credit card balances in full each month. This will not only help improve your credit score, but not having credit card payments included in your debt-to-income ratio will help ensure that you meet the income requirements for a home loan.
Employment History Matters
Being able to show a stable employment history is also vital when you are considering buying a home with bad credit. Lenders will more than likely want to see two years of stable employment history when considering you for a home loan. This doesn’t mean you need to be employed at the same company for two years, it just means there should be two years of work history with no noticeable gaps in employment.
Be Prepared to Explain Derogatory Items
Having past late payments, a bankruptcy, or a foreclosure doesn’t mean you won’t be able to buy a home with bad credit if enough time has passed. However, you should be prepared to explain the circumstances surrounding the event. This is normally done by the lender requesting that you provide a letter of explanation. A letter of explanation is simply a letter that you write explaining what put you in such dire circumstances at the time. It should be short and to the point.
The request for a letter of explanation can be unnerving to many people who are buying a home with bad credit, but it is a normal procedure and not an indication that the loan won’t be approved. The underwriter simply wants to know that this was a one-time event that won’t be repeated anytime soon.
The Bottom Line
When you find yourself wondering, “Can I buy a home with bad credit?” keep in mind that buying a home with bad credit is possible. Most people buy a home with bad credit by taking advantage of the FHA loan’s low credit score requirement and low down payment option. A minimum credit score of at least 500 will be required to qualify for a home loan, and the score needs to be at least 580 to qualify for a loan with the low down payment option. You will need a 12-month clean payment history and any bankruptcy or foreclosures will need to be 24 to 36 months in the past.
Having a large down payment will make it easier to qualify to get a home loan with bad credit. A stable employment history will also go a long way to helping ensure that you get qualified for a loan.
If you do not yet meet the credit requirements to qualify for a loan, don’t fret. Simply concentrate on making all of your payments on time and saving up for a down payment and you will eventually be able to qualify. Getting a home loan with bad credit is possible; people do it every day. Stay patient and diligent, and your dreams of homeownership will come true.
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