Having bad credit can make it harder to get approved for a mortgage. By “bad credit,” we usually refer to a financial status with FICO scores from 300 to 579 or VantageScore from 300 to 499. These scores are considered subpar and high-risk by lenders.
The good news is that having bad credit doesn’t mean homeownership is unattainable. With proactive steps in improving financial standing and the right financing, you can turn your dream home into a reality.
Know and Improve Your Credit Score
The first step is to determine your credit score. This will help you know your current financial situation and identify areas that need improvement. To know your credit score, you must obtain a copy of your credit report, which is available for “free” at AnnualCreditReport.com.
AnnualCreditReport is the only website authorized by the federal government for free credit reports. Hence, be cautious of other websites that may charge you for a report or offer additional services.
Additionally, note that every U.S. citizen is entitled to receive one “free” copy once a year from the three major credit bureaus, namely TransUnion, Equifax, and Experian. It’s highly recommended to request reports from all of them to ensure accuracy and consistency.
Once you’ve received your credit report, examine it for errors you believe are inaccurate, such as incorrect personal information, accounts you don't recognize, or late payments. If you find any discrepancies, follow the credit bureau’s dispute process to correct them immediately.
In addition to disputing errors on credit reports, take proactive steps to improve your credit scores. You can also increase your credit score by paying bills on time and reducing debt. These proactive actions improve your payment history and credit utilization ratio, which make up 35% and 30% of your credit score, respectively.
Explore Government-Backed Bad Credit Loans
If you plan to look for financing but your credit is bad, you may hesitate and wonder, “who will give me a loan when no one else will?” Fortunately, there are many borrowing options guaranteed by the government that can cater to individuals with less-than-ideal credit scores.
Federal Housing Administration (FHA) Loans
FHA loans are one of the popular government-backed loan programs designed to assist homebuyers with bad credit. They even have more lenient debt-to-income ratios, which can benefit buyers with higher debt levels.
However, FHA loans require a smaller down payment, usually around 3.5% of the purchase price only. They also require borrowers to pay an upfront Mortgage Insurance Premium (MIP), which is an insurance policy designed to protect the lender if the borrower defaults on mortgage payments. While it has a good purpose, it increases the overall cost of the mortgage, which can be a financial burden for some.
FHA loans have limitations as well. They come with loan limit restrictions based on the location and type of property and require the property to meet certain safety, security, and soundness (3S) standards, which could limit your choice of homes.
VA Loans
If you’re a veteran, active-duty personnel, or a surviving spouse, you might qualify for Veterans Affairs (VA) loans guaranteed by the U.S. Department of Veterans Affairs. They don’t require a minimum credit score, making them an attractive option for prospective homeowners with bad credit.
Moreover, VA loans offer competitive interest rates and don’t require a down payment, unlike FHA loans. However, they’re exclusively for a specific group of people mentioned earlier. Borrowers might also need to pay a funding fee, which can add to the overall cost of the loan.
USDA Loans
U.S. Department of Agriculture (USDA) loans also don’t have a down payment and offer low interest rates, making them an excellent choice for low-income homebuyers. Applicants with a credit score below 640 may still qualify but will undergo more stringent underwriting procedures.
The thing is, USDA loans are mainly designed to promote homeownership in rural areas, limited to eligible rural and suburban neighborhoods. They also often come with income limits that vary by region.
Further, other private lenders specialize in financing homebuyers with bad credit. These include Subprime Mortgages, Adjustable-Rate Mortgages (ARMs), Lease-to-Own/ Rent-to-Own Programs, Homebuyer Assistance Programs, and Co-Signed Loans, to name a few. Each varies, depending on the private lenders’ standards, so seeking advice from financial professionals is recommended.
Seek Professional Guidance
Working with a knowledgeable mortgage broker or financial advisor can be invaluable when navigating the complexities of the home-buying process with bad credit. They’re especially helpful when dealing with private mortgage lenders.
These professionals can provide personalized advice, help you understand your options, and guide you toward lenders who may be more willing to work with individuals with lower credit scores.
Final Thoughts
Buying a house through financing and with bad credit is possible. While it isn’t as easy as having a good score, there are many borrowing options to choose from. However, be sure to do your due diligence and carefully consider the long-term implications of each financing. It’s also equally crucial to improve your credit over time to secure more favorable loan terms in the future. Lastly, if unsure, seek professional help to avoid costly mistakes.
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