If you have bad credit, I have good news for you: Buying a house is not an impossible dream. It actually is possible to get a mortgage with bad credit.
Let’s start by discussing what qualifies as bad credit. FICO credit scores, which are the most commonly used in the U.S., fall somewhere in the range of 300 to 850. The higher your score, the better your credit. Scores of 700 and above generally qualify as good to great. Scores between 680 and 700 are acceptable. Scores between 620 and 680 are considered mediocre, but such borrowers are still likely to be approved for a mortgage. Home buyers with credit scores below 620 are unlikely to be approved for a loan without significant effort.
Your credit score and credit history matter, because poor credit indicates to lenders that you are an untrustworthy borrower. In other words, a lender would be taking a greater risk by lending you money over someone who has great credit. At the very least, you will have to pay for the additional risk with a higher interest rate. Put another way, if a lender is willing to take a risk by lending you money, you will end up paying more for the loan than someone with better credit.
Notwithstanding a higher interest rate, home ownership can still make financial sense. If you crunch the numbers and decide buying a home is still a sound choice, here are some things you can do to convince a lender you’re worth the risk:
– Start by making sure your credit report is accurate since it comprises a significant part of your credit score. You can obtain free copies of your credit report from the three major credit bureaus at AnnualCreditReport.com. Check each report for any errors, and file a dispute to correct any errors you find.
– You should also check to see if you are eligible for any special mortgage programs, such as VA Home Loans, which are available to servicemembers, veterans, and their eligible surviving spouses, or FHA Loans, which insures certain mortgages, thus allowing lenders to offer mortgages to borrowers with credit scores as low as 500 and down payments as low as 3.5 percent. (Without the FHA guarantee, lenders are unlikely to take a chance on borrowers with a credit score under 620.) If you belong to any membership organizations such as a credit union, it is worth checking to see if their loan requirements are flexible for members, especially if you are a long-time member in good standing.
– If at all possible, you should save up for as big a down payment as you can muster. A bigger down payment reduces the risk to lenders, because you’re borrowing less money, and also because it makes you less likely to default and abandon the property because you have invested significantly in it. Therefore, lenders will be more willing to lend you money if your down payment is substantial. If your credit is particularly poor, a large down payment – i.e., as close to 100 percent as possible – may be the only way to obtain a mortgage.
– Take steps to improve your credit score before you start shopping for a home. Actions like paying off past due balances, paying down credit card balances, minimizing credit card usage, increasing credit card limits, and paying off non-revolving debt, such as student and car loans, can increase your credit score.
– Finally, consider hiring an experienced mortgage broker to help you get the best mortgage possible. A mortgage broker is a middleman between borrowers and banks or other lenders and therefore should know which lenders are more likely to approve mortgages to borrowers with bad credit, and what they will be looking for as reassurance that you are a trustworthy borrower.