You’ve likely heard you need good credit to buy a home, but what happens if you have bad credit?
Are you out of luck?
The good news is that there are loan programs for people with bad credit. The bad news is that you will need compensating factors for the bad credit.
Here’s how to make the most of your situation.
Government-Backed Loans are the Best Option
If your credit score is lower than 660, consider government-backed loans, such as FHA loans.
They have more flexible guidelines, allowing credit scores as low as 580, and still only requiring a 3.5% down payment.
If you have even worse credit, you may still qualify for FHA financing, but a credit score of 500 – 579 will require a 10% down payment.
FHA lenders can offer more flexible guidelines because they have a government guarantee. If you default on the loan, the FHA will pay the lender back, so they don’t lose much on the loan.
If you’re a veteran or a low-income family living in a rural area, USDA and VA loans may also be an option. However, the VA doesn’t have a specific credit score requirement for veterans, and the USDA requires a 640 credit score.
If you have a bad credit score, you may need other ‘good factors’ to compensate for the lower credit score.
Some common compensating factors include:
- Low debt-to-income ratio – Your DTI tells lenders how much of your monthly income is committed to debts. The lower your DTI, the less risk of default you pose. FHA loans allow DTIs of 43%, but the lower you can make your DTI, the easier it is to qualify.
- Larger down payment – FHA loans require a 3.5% down payment, but if you have a low credit score, you’ll increase your chances of better rates and terms if you put more money down on the home. While you don’t need a 20% down payment, any down payment higher than 3% will help your case.
- Stable income and employment – Most lenders require a 2-year stable income and employment history. Still, the more stable your employment history is, the easier it is to get approved with bad credit. For example, if you’ve been at your job for ten years and consistently earned more income annually, it can compensate for your bad credit score.
What to Consider Before Buying a Home with Bad Credit
Before buying a home with bad credit, ask yourself the following:
- Can I afford the payment?
Think about why you have bad credit. Have you had trouble managing your finances? Will a mortgage payment add to your challenges? Don’t take on a mortgage until you’re comfortable that you can make the payments on time.
- Do I have money to put down?
Most loan programs require at least a small down payment. When you have bad credit, a higher down payment is better. Think about how much capital you have to invest in the house without putting yourself at financial risk. The more money you invest, the lower your mortgage payment will be.
- Am I ready to settle?
If you aren’t ready to settle in one area, don’t buy a home yet. Buying a home means you tie up your funds for the time you own the home. It can take months or longer to sell a home and get your capital back, so make sure you’re ready to settle and can part with your funds.
- Should I improve my credit first?
If you can fix the reasons your credit score is low, consider fixing them and improving your credit score. Lenders consider your credit score first when determining if you qualify for a loan and at what rate/terms. Therefore, the better your credit score is, the better loan you’ll get, saving you money in the end.
You can buy a home with bad credit, but it’s best to maximize your credit score first. If you’re in a situation where you must buy a home now, FHA loans are a great option. If you can wait and fix your credit, you may save more money monthly and over the loan’s term.
Before settling for any loan, compare your options to determine that you’re getting the loan with the best rate and terms. Some lenders charge more upfront for borrowers with bad credit. Before accepting this, see what other lenders offer and determine which loan makes the most sense.