Can I buy a home with bad credit?
This is a common question, and many potential home buyers assume the worst if they have troubled credit history. Yes, you can buy a home with bad credit. But the home loan options are likely different or limited compared to those buyers with higher credit scores.
You’ll find that government backed loans, such as the VA loan, FHA loan, and USDA loan, have relaxed requirements compared to conventional loans. Each has their own specific guidelines, but borrowers do not need a perfect credit history to become qualified.
Before diving into the home loan alternatives suited for those with questionable credit, here’s a refresher on some of the acronyms and definitions associated with the home loan applications. You’ll find them throughout the loan qualification descriptions.
A personal credit score calculated by the company, FICO, formerly named Fair Isaac Co. FICO gathers personal financial information to determine an individual’s risk for taking on more debt and assesses their ability to pay bills on time. FICO uses credit reports from Equifax, Experian, and TransUnion to determine an applicant’s credit score.
Experian breaks down their credit ratings as such:
- Exceptional: 800-850
- Very Good: 740-799
- Good: 670-739
- Fair: 580-669
- Very Poor: 300-579
Experian also reports that 67% of Americans have a Good or better FICO score.
Debt to Income Ratio (DTI)
Lenders use a DTI formula to determine the risk involved with offering you a loan. DTI divides total monthly debt payments by gross monthly income; 20% is the standard for what is considered a low DTI.
Private Mortgage Insurance (PMI)
Conventional mortgage lenders usually require home buyers to purchase this insurance if they offer less than 20% down payment. The insurance protects the lender from loss if a foreclosure occurs.
Mortgage Insurance Premium (MIP)
The FHA loan calls for home buyers to purchase an insurance policy if the down payment is less than 20%. It is either paid at closing or paid in 12 installments.
Loans Available for Those with Bad Credit
The following loans are all backed by the federal government and prove to be easier to obtain for those with low credit scores. The overall goal of the VA, FHA, and USDA loans are to provide as many eligible Americans with the opportunity to become homeowners. The details vary, but overall, the qualifications are less strenuous than traditional home loans.
Can You Buy a Home with Bad Credit? Take a Look at These Options!
The VA Loan
By far one of the easiest ways for a military member to work around a low credit score is to take advantage of their VA loan benefit. Mortgage lenders are much more willing to offer VA loans with competitive interest rates to applicants because of the U.S. Department of Veteran’s Affairs’ guarantee.
Although there is not a set credit score requirement, 620-640 is the typical range used by lenders to qualify a servicemember for a VA loan. The VA loan is also easier for servicemembers to secure because a down payment is not required, nor is PMI. And, for those with troubled financial histories, such as a bankruptcy, the VA Loan is a forgiving option. A higher DTI ratio is also tolerated, thanks to the backing of Uncle Sam.
For all the benefits a VA loan provides a servicemember with bad credit, it does have a drawback with the funding fee assessed. It can be paid out separately, or within the home loan. In some situations, military members with disabilities can apply to have the funding fee waived.
FHA loans are known for leniency on qualifications. The Federal Housing Administration initially created this loan program to help those earning low to moderate incomes become homeowners. Here are the details:
- Minimum credit score: 580.
- Down payment as low as 3.5%.
- Higher DTI acceptable if credit score starts in the mid-600s.
- Some FHA lenders will accept proof of less than two years of employment.
It is possible to qualify for an FHA loan if you’ve experienced a bankruptcy or foreclosure,
but the mortgage lender will require proof to see if good credit has been maintained after the debts were settled. FHA applications may be submitted between 1 and 2 years past bankruptcy and 3 years beyond the foreclosure date.
There is a misconception that FHA loans are only offered to first time buyers. This is not the case--any buyer may apply. However, those who put less than 20% down will have to pay MIP for the entire length of the loan.
These loans have similar qualifications to the FHA and VA loan programs, but are offered through the U.S. Department of Agriculture. The intent is to offer mortgages to low to average income earners in rural areas.
- No set credit score standard, but a score of 620 is typical.
- Zero down payment required.
- DTI percentage of 50 or lower needed.
- PMI not required.
The loans are processed through the USDA Rural Development Guaranteed Housing Loan Program. The majority of loans are designated for rural settings, but it's a good idea to check with a USDA approved lender because there are surprising nooks and crannies of suburban locations that are eligible.
More Options to Find a Loan if You Have Bad Credit
If you’re unhappy with the terms provided by the FHA, VA, and USDA loans, there are other options, but are likely challenging.
A very large down payment can offset bad credit. A hefty sum assures the lender you are able to pay the monthly payment. By investing in the property with a substantial amount of money, lenders recognize your seriousness as a home buyer. With cash in hand, more loan products are available.
It's a contentious suggestion, but for some, asking a family member with good credit to cosign a home loan is plausible. A co-signer is on the hook for the mortgage each month if you are unable to make payments. The burden that falls on your co-signer, should you be unable to pay, could wreak havoc on their financial stability. A co-signing deal should not be entered into unless each signer has clear acknowledgement of the details and responsibilities. If not, a permanently damaged relationship could be the end result.
Federal agency Fannie Mae, provides first time home buyers, who might not have a substantial credit history the opportunity to purchase foreclosed homes with as little as 3% down. The program also offers up to 3% of the purchase price back in the form of closing cost assistance. With their partner HomePath Ready Buyer, Fannie Mae requires applicants to become educated on the home buying process through coursework on their app.
The Department of Housing and Urban Development (HUD) has a state-by-state directory that leads home buyers to state and local government assisted home buying programs.
How Can I Improve My Credit Score?
Credit scores are not permanent. There are many options to repair credit problems and increase your credit score, which will allow lower interest rates on loans and open more possibilities from lenders. Give yourself plenty of time before applying for a home loan to correct botched credit.
Begin by examining each of your credit reports. Errors vary from incorrect addresses to evidence of identity theft. The credit bureaus offer online assistance for filling disputes and corrections. Any corrections made, especially regarding late fees or outstanding balances help to increase your credit score.
Continue to pay all of your bills on time and in full. Do not let any unpaid accounts move into collection. If you find a collection account on your credit report, work diligently to have it removed by communicating with the creditor to figure out a manageable schedule for payment.
Reduce your overall DTI. Paying off remaining balances on car payments, credit card bills, or other debts helps free up more money to pay for a mortgage. Lenders like to see a DTI that sits under 43%. This is the percentage reached after factoring in the mortgage payment each month.
Possessing a large amount of unsecured debt, such as credit cards, medical bills, or student loan, is a red flag for home loan lenders and credit bureaus. For credit cards, lenders and credit bureaus look at your credit utilization ratio to see if you are “maxing out” available credit. A $1,000 limit credit card with a $800 balance is unfavorable, given your credit utilization ratio is 80%. Work to pay off the balances, and your credit score will improve.
You should feel relief knowing bad credit doesn’t automatically negate the chance to own a home.
There are several viable options, but expect that some financial sacrifice has to be made, whether it's a higher interest rate, larger down payment, or the need for PMI.
Reevaluating how much of your income can reasonably put toward a mortgage is a simple way to start considering which home loan choice may be right for you. After that, use referrals to find a mortgage lender who has experience working with those who have less than perfect credit. Their expertise will help avoid unnecessary mistakes and wasted time.
Financing is a large part of what homeownership is all about. For more information, head over to MilitaryByOwner’s home financing resource articles to begin researching everything you need to know!