How to Buy a House With Bad Credit
Know Your Credit
It’s important that you are an informed consumer when you try to buy a home. Going into the mortgage process without knowing what type of credit you have could be detrimental. You should know your score and how your credit history looks to make sure you are getting fair treatment. If you don’t know your credit score and/or history, you won’t know what type of rate and term you deserve.
Start by pulling your free credit report here. You can pull one bureau or all three. If you only pull one, we recommend pulling Trans Union. Go through the report and make sure everything that reports on there is yours and that it’s reported correctly.
If there are any errors, dispute them with the credit bureau right away. Make sure you provide the request in writing and include plenty of detail. You should also include as much documentation as you can to prove that there are errors on your credit report.
Once you know your history looks right, it’s time to know your credit score. You can usually have access to the score through your bank or credit card companies. Look online with any account you have to see if they offer free access to your credit score. Keep in mind, this won’t be the exact score that lenders see, but it will be close.
If there’s anything you can do to improve your credit score quickly, such as getting your past due payments caught up or paying off a credit card, go ahead and do it. Otherwise, keep going with the steps below to get your mortgage.
Gather Compensating Factors
One way to improve your chances of getting approved for a loan even with bad credit is to have compensating factors. These are things that can make up for the fact that you have a ‘bad credit score.’ A low credit score poses a high risk to lenders. It makes them think that you might not stay on time with your payments or that you will default entirely on the loan.
In order to minimize the risk, you should try to provide one or more of the following compensating factors:
1 Large down payment – The more money you can invest in the home, the higher your chances become of getting approved. Lenders like it when borrowers have their own money invested in the home. It gives you incentive to make the payments even when times get tough.
2 Low debt ratio – If you combine a low credit score with a high debt ratio, you have the recipe for a disaster. Lenders want to see that your gross monthly income isn’t completely accounted for each month already. They want to know not only that you have enough money to cover the mortgage payment, but that you also have enough disposable income to cover the daily cost of living without feeling like you have to sacrifice.
3 Stable income and employment – You’ll have the best chances of getting approved if you have been at the same job for several years. If you are bouncing around to different jobs and your income is all over the place, you don’t paint the picture of reliability. If, on the other hand, you are at the same job for a long time and your income steadily increases, you should reliability and consistency, both of which lenders want to see.
Start Shopping Around
Now that you are armed with the information regarding your credit and you figured out which compensating factors you have, it’s time to shop around for a loan. We recommend obtaining quotes from at least three lenders, but you can even get quotes from more if you have time. As long as you shop for a mortgage with different lenders within a few week time span, your credit report will only get hit with one inquiry. Credit bureaus recognize the need to shop around to get the best interest rate.
As you shop around, we suggest trying any of the following loan programs:
FHA, USDA, Subprime loans
You may have the best luck with FHA or subprime loans, depending on your credit score. USDA loans require a 640 credit score and you must buy a property that the USDA considers rural. The FHA only requires a 580 credit score and subprime loans have varying credit score requirements.
Even if you decide to go the FHA route, you will run into lenders that have different requirements. Lenders just have to follow the FHA rules at a minimum, but they are free to add their own requirements onto them. This could mean that you’ll come across lenders that have stricter credit score requirements, which may make it harder to get approved.
Choosing the Right Loan
The toughest part of buying a home with bad credit will be choosing the right loan. Chances are that you will be faced with decisions regarding adjustable rate mortgages, fixed rate mortgages with higher interest rates, and high closing costs.
We encourage you to look at the big picture. Try not to focus on the interest rate alone. Instead, look at the total cost of the loan over its lifetime. What are the closing costs? Are you paying points? Is there an option to buy the interest rate down if you want? These are things you should consider. Also, determine how long you think you will stay in the home. Is this your forever home? If so, you may want to take the loan that has the lowest interest rate and yet is still a fixed rate loan. If you know you’ll move or that you will refinance in the next few years, you don’t have to focus on the interest as much as you will eventually have a different loan in the near future.
As you can see, it’s a process getting a mortgage with bad credit. It can be done though. You just have to be diligent in your efforts. Don’t give up or think that lenders won’t approve you. Maximize your credit score and your compensating factors and see what lenders have to say about you buying a home.