Bad credit can seriously derail your dreams of home ownership. Your credit rating will be a key figure used by mortgage lenders as they evaluate your ability to repay a home loan. Your credit rating will play an important role in determining both the total sum of the loan banks are willing to provide you for a new home and the interest rate that you’ll pay each month on top of your original loan. For those with poor credit, buying a home may even feel like an impossibility. But there are actually home loans designed to assist prospective buyers with bad credit.
Rocket Mortgage points out that while it is indeed challenging to secure favorable mortgage terms with bad credit, there is technically no exact credit rating requirement to qualify for a loan. Even so, the mortgage experts advise that those with a credit rating of 500 or below would likely be better served by taking steps to increase their credit rating before exploring the possibility of home ownership.
But we’ll get to that in a bit. For now, let’s focus on what you can do to secure a home loan in spite of a less than optimal credit rating.
Why does your credit score matter when buying a house?
The banks who will lend you the money for your home mortgage must perform due diligence to determine whether or not you are financially fit to manage your repayment obligations. And rest assured that when you do undergo the home purchasing process, that due diligence will be exhaustive. Be prepared to provide detailed documentation of every aspect of your financial life. But also be aware that in almost every case, the very first indicator that banks and lenders will use to determine your financial fitness is your FICO® credit score.
According to Quicken Loans, the FICO® Score, which was first introduced by the Fair Isaac Corporation in 1956, “help[s] lenders calculate the interest rates and fees you’ll pay to get your mortgage.”
Every prospective borrower carries a score, in a range between 300 and 850, which is constantly adjusting according to your financial activities. The higher your score, the better your credit is said to be.
Your credit score is among the most important figures–along with your employment status and debt-to-income ratio–in determining your eligibility for the preliminary step of loan application approval. And once again, while there is no exact credit score requirement for home ownership, there is a minimum score below which you would be highly unlikely to secure a conventional home loan.
“Good” or “Excellent” credit scores will usually be met with loan application approval. However, carrying a heavy load of credit debt, demonstrating a history of missed payments, or showing delinquencies in your credit report can lower your credit score into the “Fair” or “Poor” range. Those with “Fair” or “Poor” credit ratings might find it difficult to secure loan application approval for conventional mortgages. But that doesn’t mean buying a home is impossible. It just means that your options are limited, and that you will likely need to take some additional steps to prove your financial fitness to a prospective lender.
What Credit Score Do You Need To Buy a House?
While there isn’t a specific credit score that you must have, the range of your credit score will absolutely impact the size and type of loans for which you would be eligible. Be aware that other important factors will still figure into the size of your loan and your interest rate including your employment status, your income, how much debt you carry, and the type of property you plan to purchase. Also note that the exact terminology used to describe each credit score range can vary depending on the company or service reporting your score. One company may use the term “excellent” while another might use the phrase “very good” to describe a similar score range. Likewise, one service might use the word “poor” to describe a score range that another service might refer to as “bad.”
That said, NerdWallet provides a breakdown of these score ranges and the likely array of lending options available to prospective home buyers in each category.
Credit Score of 700 and Above
This is considered a “good” to “excellent” credit score. Prospective homeowners with a credit score at 720 or above will find willing lenders and, provided all other financial indicators align with this excellent credit rating, will likely secure favorable mortgage terms. Those with an “exceptional” score of 780 to 850 will be in line for the lowest interest rates.
Credit Score of 620-699
This is considered a “fair” to “good” credit score. Provided your other financial indicators are strong, you may be able to qualify for a conventional loan. The higher you fall in this range, the more likely you are to gain conventional loan approval and the lower your interest rate will be. If you fall into the lower end of this range, you may face the risk of rejection by some banks. If you do find that you are unable to secure a conventional loan with acceptable terms, consider the alternative options available to prospective borrowers in the range here below.
Credit Score of 500-619
A credit score in this range is considered “bad” to “fair.” With a score in this range, you are unlikely to qualify for a conventional loan. Your best option in this case will likely be an “FHA loan.” This is a loan which is secured by the Federal Housing Administration. The terms applying to this loan may vary depending on where you fall within the score range noted. In most cases, the terms of securing an FHA loan will include satisfying any outstanding judgments or collections. However, down payment requirements may vary, with applicants on the lower end of this score range typically being required to put down a larger sum up front. For more on the breakdown of terms, see the subsection below on Government Insured Loans. Also see this section if you are a veteran or a resident of a small or rural community. These demographic features may qualify you for loan programs backed by the Department of Veterans Affairs and the U.S. Department of Agriculture respectively. These loans are often available to eligible applicants in spite of a “fair” or “bad” credit rating.
Credit Score of 500 and Below
For those with a credit score of 500 or below, or with no credit history at all, securing even a government-backed loan is highly unlikely. If you fall into this category, your first step is to begin improving your credit right away. You can gradually repair your credit score by paying down debts, requesting higher credit limits, look into your credit report for errors, disputing incorrect notations, and generally tidying up your credit history by closing unused accounts, consolidating debts, and closely monitoring your credit score for changes. Revisit the idea of seeking a home loan when you’ve succeeded in moving your score up a minimum of 100-200 points.
Now that you understand how your credit score can impact your path to home ownership, you’ll want to know and act on the following 5 tips.
Five Tips for Buying a House With Bad Credit
1. Start Actively Monitoring Your Credit
Wherever you fall on the credit spectrum, make sure you have a firm grasp on your credit score as well as the contents of your credit report. Create an account with a free credit monitoring website like Credit Karma or WalletHub. Know your credit score and confirm the accuracy of the information in your report. This is the best way to identify errors, to dispute inaccurate charges that might be affecting your credit rating, to spot dormant accounts or lapsed collections from your distant past, and even to detect suspicious activity, fraud, or identity theft.
All of these are details that will show up when your mortgage lender reviews your application. Make you sure you spot these discrepancies and correct them before they can delay or even derail your home-buying plans. As an added bonus, regularly monitoring your credit rating can help you understand how factors like credit spending, timely payments, and opening or closing accounts can impact your score. This puts you in the driver’s seat when it comes to credit repair and long-term credit maintenance.
2. Look Beyond the Banks For Lending Alternatives
You may have another option if you’ve been rejected by traditional banks, and in some cases, you may even be able to qualify for a conventional loan with a less than stellar credit score. According to BankRate, there are various types of businesses that make their profit through home loans, including non-bank lenders, online lenders, and credit unions. BankRate even suggests that you might be able to “Let them compete for it to see where you get the best offer.” Still, be aware that these lenders, though willing to approve loans for those with lesser credit ratings, will likely seek additional assurances from suboptimal borrowers like high down payments and high interest rates. Make sure you shop around and do your research before applying for a loan with a less traditional lending institution.
3. Make a Big Down Payment If You Can
If you have a bad credit rating, the best way to compensate is to throw a lot of money at the problem. No. Seriously. According to Rocket Mortgage, “Cash is your best friend when you have bad credit and the more of it you have to use toward a down payment, the better. The reason for this is that your credit score might only qualify you for a certain mortgage loan amount. If you can cover the difference with cash, you can still afford the home you want.” This may be especially true when you’re dealing with a non-bank lender. For applicants with less than sterling credit, a robust savings is the most effective alternative. The more you can pay upfront, the less risk your lender will be taking on by securing your loan.
4. Talk to a Housing Counselor
Of course, it bears noting that many applicants with bad credit will also lack the cash resources necessary for a large down payment. If this describes your situation, and if you have been rejected for a conventional loan because of your credit score, you still have a number of options. But you should make sure you understand all of these options before approaching a mortgage lender. Reach out first to the Housing and Urban Development (HUD) agency where you can talk to a qualified housing counselor. Here, you can learn not just about the array of government-backed loans for which you may be eligible, you can also learn about public assistance programs, credit repair programs and other services aimed at supporting aspiring homeowners with less than perfect credit.
5. Get a Government-Insured Loan
If you do have a credit rating between 500 and 620, a housing counselor will more than likely advise you to consider a government-insured loan called an FHA. The Atlantic Bay reports that the Department of Housing and Urban Development will typically approve borrowers for an FHA with a score as low as 580 alongside a 3.5% down payment. If your score falls between 500 and 579, you may still be approved for an FHA loan, but you would likely need to provide a 10% down payment first. And as noted above, most FHA loans will further require that all judgements and collections have been resolved first.
There are additional government backed loans for those with special eligibility such as active duty military personnel, veterans, National Guard members, those in the military reserves, and the spouses of deceased veterans. The Department of Veterans Affairs may back a VA loan for individuals falling into these categories and meeting the VA’s specific terms for eligibility. For those with military affiliation and fair or poor credit, this may be a pathway to a home loan. Visit the Veteran Benefits Association to learn more.
A similar loan option is available to families and individuals living in rural areas. This loan, provided by the United States Department of Agricultural, is designed to create affordable housing opportunities for individuals living in smaller communities. As the Atlantic Bay notes, USDA loans are not limited to those living only in farming communities. If you have less than optimal credit and reside in a smaller community, find out if you could qualify for a USDA home loan. This is a particularly beneficial loan to eligible applicants because no down payment is required.
Additional government-backed loans include an array of programs for first time home buyers with suboptimal credit. Available programs and terms of eligibility will vary from state to state. For a by-state listing of first-time home buyer loan programs, take a look at this table from BankRate.
And if you happen to find yourself in the opposite situation–short on cash but long on good credit–you might want to check out The Fannie Mae HomeReady and Freddie Mac Home Possible loan, which will allow you to procure a loan with just 3% down and a lower mortgage insurance rate.
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As you can see, while it may be difficult to get a home loan with poor credit, it is not impossible. You may have a variety of options. While you may not be able to own the home of your dreams right away, you could at least buy the home of your needs. From there, use timely mortgage payments and diligent credit monitoring to build your credit, and pave your way to the next big step.