How to buy a house with bad credit is one question we hear from our readers often. You may have been told that buying a house with bad credit is a virtual impossibility; or if you somehow manage to get a mortgage, you’ll be hit with a cripplingly high-interest rate. While it is unquestionably tough to purchase a property with poor credit, neither of the two statements above are correct. There is a program that can help you when you are looking at buying a house with bad credit and it provides you with a reasonable loan rate.
Mortgages usually have out-of-reach requirements for those battling poor credit. Borrowing for a house is the biggest expenditure most people ever face and lenders will get personal to deduce your creditworthiness. You’ll need to show information about your student loans, auto loans, credit card balances, outstanding medical bills, and all other financial obligations.
Lenders use this information (along with your pay stubs) to calculate your debt-to-income ratio. If this ratio is too high, you’ll be denied. Most lenders want this ratio below 36%, meaning your monthly debt payments must not absorb more than 36% of your salary.
Talk to one of our debt specialists for FREE. They can help answer any questions you may have when looking to buy a house with bad credit.
What is Classified as a ‘Bad’ Credit Score?
Every credit reporting agency calculates a Fair Isaac Corporation (FICO) score based on your credit information. This score can range from 300 to 850. A score of below 580 places you in the bad credit range.
Your credit score is based on the following information:
- Payment History
- Debt-to-Credit Utilization Ratio
- Credit History Length
- New Credit
- Types of Credit
While there are ways to boost your credit score, they take time which isn’t helpful if you’re buying a home with bad credit in the near future. Fortunately, it could be possible to benefit from a Federal Housing Administration (FHA) loan; a low-interest mortgage offered to applicants with bad credit scores.
Am I Eligible for an FHA Loan?
Just to be clear, the loan is ‘backed’ by the FHA but you still need to deal with lenders. The FHA loan is theoretically available to applicants with a credit score of 500-580. However, prospective lenders can still turn you down and up until 2017, it was difficult to get a loan with a credit score of under 620. As of December 2017, 23.6% of applicants with a credit score of 600-649 were approved for an FHA loan; only 5.25% of applicants were approved with a credit score of 550-599.
The FHA loan program was implemented in 1934 and has helped over 40 million Americans to achieve their dream of homeownership. It recently announced that it would be sweetening the deal for lenders and the new changes could help 100,000 extra families own a home each year. Here are the organization’s credit score minimums; please take note of them if you are intent on finding out how to buy a house with bad credit:
FHA Loan Requirements
- A score of 300-499: Not eligible for an FHA loan.
- A score of 500-579: Eligible with 10% down payment.
- A score of 580+: Eligible with 3.5% down payment.
Unfortunately, there are no programs for people with credit scores below 500. Indeed, mortgage experts suggest that there is little possibility of a loan with a score of under 530.
As you can see, you need your credit score to be above 580 if you wish to benefit from the 3.5% down payment option. For the sake of calculation, it means you can buy a $300,000 house with a $10,500 down payment. If your score is between 500 and 579 however and you are approved, you require a 10% down payment which is a substantial sum of $30,000.
Bump Up Your Down Payment On a House
While this is admittedly a difficult undertaking, it is one of the best ways to buy a home with bad credit. Some lenders will approve you for a home loan even if you have poor credit, so long as you make a significant down payment. As you’ll need 20% of the home’s purchase price just to avoid Private Mortgage Insurance (PMI), most lenders will expect applicants with bad credit to put down 30% of the property’s price. Using our hypothetical $300,000 example, you’ll have to save $90,000!
What a Bad Credit Score Does to Mortgage Rates
A 100-point drop in your credit score could add 0.25% or even 0.5% to your rate while a person with a good credit score can expect a rate of at least 1% lower than someone with a poor or bad credit score. If you receive a 30-year fixed rate loan of $300,000 at 4%, your monthly payments are around $1,300. At a rate of 5%, those payments increase to over $1,500. Over the course of your mortgage, that 1% difference equates to over $40k extra in interest! We encourage our clients and readers to visit our Credit Card Interest Calculator to get a better idea of how much you’ll be paying on interest and principal.
You Can Buy a House with Bad Credit, But Try & Give it a Boost First
While it is untrue to suggest that bad credit will prevent you from becoming a homeowner, it will make things harder. If you are unable to get the FHA loan, you’ll have to save up a large down payment and lenders will issue a higher interest rate because they see you as a greater risk. Check your credit report for errors, pay high-balance and high-interest credit cards first, and try to make all loan payments on time. Also, don’t forget to check out our finance charge calculator to see exactly how much you’ll be paying on interest and principal.
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