Owning a home is a dream for many people. It is a financial choice that may provide stability and turn into an investment that can help finance other plans. But, for people that have bad credit, the possibility of homeownership may seem like a distant dream. Luckily, there are realtors that work with bad credit.
Credit scores are a type of financial passport that can make large purchases both affordable and straightforward. And a poor credit score is a restrictive economic reality that can keep many people from taking advantage of everything from credit cards to rental properties.
For the person that wants to buy a house but has bad credit, it’s understandable why they would believe that a low credit score can keep them from ever owning a home of their own. Fortunately, you don’t have to have a perfect credit score to get a mortgage.
There are options available to people who want to buy a house with bad credit. But it will take the combined effort of connecting with the right lender while also boosting your credit score. In this article, we’ll take a look at how to do both.
What Is a Bad Credit Score?
Everyone knows that poor credit can stop you from getting things that you might want to purchase. However, not everyone understands what a low credit score means—or even where it comes from. The first thing to know is that all of the information that makes up your score is in your “credit report.”
A credit report is a lengthy document that shows your borrowing history, past loans and payments, credit card usage, and more. The info in your credit report will determine what your score is. It’s crucial to keep track of your credit report and alert the credit bureau if there are any mistakes.
Your credit score is a rating of how good or bad of a financial risk you are. It sums up your ability to repay a loan based on your past and current financial habits. Understanding your credit score is very important when you are looking to buy a house.
Knowing where you stand along the credit spectrum will help guide you in your search towards lending options that can fit your budget and overall financial goals.
Credit Score Breakdown
Along with their impact, here is a breakdown of the five major factors that determine your credit score:
Payment History (35%)
Your payment history records your payments to the people and businesses that you owe money to. Above anything else, your potential lenders want to know if you will be able to repay their loan. That fact makes your payment history the most crucial determinant of your credit score.
Even if you have a bad credit score, moderately healthy payment history can open a few doors for you. This is why you should always pay your bills on time.
Credit Utilization (30%)
Credit utilization is a ratio that measures the amount of available credit that you are using. For example, if you had a $120 balance on a credit card with a limit of $1,200, then your credit utilization would be 10%. A reasonable credit utilization rate stays at or around 30%.
Credit History (15%)
This is a listing of all the credit accounts that have had or currently have. Credit history can indicate some level of Creditworthiness by showing that you have experience managing credit over a long period.
New Credit (10%)
Creditors could see opening up several new credit accounts as a sign of financial instability. People should avoid starting new accounts, particularly new credit cards, as they look for home financing.
Credit Mix (10%)
A credit mix is a type of review of all of your credit accounts and their variety.
Having different types of credit accounts (like a secured car loan and an unsecured credit card, for example) can show home loan lenders that you have experience managing different types of accounts. However, this factor isn’t considered as strong as the others.
Credit bureaus like Experian, Equifax, and TransUnion compile all this data and use it to calculate your overall creditworthiness and make it available to any business or financial institution building a financial profile for you.
This credit review is listed as a three-digit number known as your credit score. Credit scores range from 300-850. The better your credit score, the better your chances of getting suitable financing on a home:
- 300–499 Very Poor/Bad
- 500–600 Poor/Bad
- 601–660 Fair
- 661–780 Good
- 781–850 Excellent
As the chart above details, a score of 600 or below would be considered a bad credit score. Although 20% of Americans are living with bad credit, they can still get a mortgage.
What Is a Mortgage?
The cost of a home is typically more than the average person would save or has available for an outright cash purchase. So, the majority of homeowners use loans to buy their properties.
The loan that you get to buy a home or any other piece of real estate is called a mortgage.
A mortgage is a secured loan, which is a loan that is backed by some piece of collateral. In the case of a mortgage, that Collateral is the house itself. A mortgage allows a buyer to put down a small amount of money and then make payments in installments.
Mortgages are long-term installment loans given with terms that last 15 or 30 years and can come with penalties for early repayment.
Lots of mortgages carry a fixed interest rate that won’t change over the life of the loan—which means that your monthly mortgage payments will pretty much stay the same, regardless of your home’s rising value or the general fluctuations of the housing market in general. There are also adjustable-rate mortgages (ARMs) available that rise or fall based on interest rates at any point in time.
How To Get a Mortgage
Banks and credit unions typically issue mortgages. They can also be provided by private companies that deal specifically with mortgages. Lenders will approve or deny a mortgage through an application process called underwriting. This is where they assess or measure the risk of giving a loan to a potential borrower.
During the process, an underwriter will evaluate your assets and income to see if you can truly afford the loan. No matter the details, every mortgage loan is subject to a credit check and evaluation of your credit history.
This evaluation will affect the decision of the lender and the amount of the loan. The greater the risk to the lender, the higher the interest rate for the borrower.
Can I Still Get A Mortgage With Bad Credit?
The answer is yes! You can still get a mortgage with bad credit.
Many lenders can—and do—make lending decisions that put people in the homes of their dreams by evaluating other factors outside of credit scores. Qualifications such as employment and income can also make the difference between the approval and denial of a loan.
While people with bad credit can make some gains with these kinds of qualifications, one of the most significant determinants outside their credit score may still be a problem: The down payment. Lots of times, a bad credit score also means that saving may be little to nonexistent, But there is assistance available.
FHA Loans
One of the best ways to continue on the home buying path with lousy credit is through the use of a loan administered by the United States Federal Housing Administration (FHA).
This loan was created during the Great Depression to help the housing market stay afloat by funding real estate purchases for homebuyers. An FHA loan is for borrowers who have lower incomes and credit scores that may not allow them to qualify for a conventional loan.
An FHA loan is also a guaranteed loan that the federal government backs. That means that if the buyer becomes unable to repay the loan (or defaults), then the government covers the loan at no cost to the bank, credit union, or private lender that issued the mortgage. This coverage reduces the lender’s risk, which allows them to work with buyers who may have bad credit.
How Do FHA Loans Work?
With these loans, an approved buyer can borrow as much as 96.5% of the purchase price. With that coverage, the buyer only needs to come up with a down payment as low as 3.5% of the home’s value.
This reduction in buyer responsibility can make the down payment for a home much more accessible; it could be pulled from savings or perhaps a friend or family loan—options that may require little to no additional fees, like interest.
Additionally, many states and local governments offer first-time or low-income buyers grants or for people interested in moving into neighborhoods seeking revitalization.
A conventional mortgage loan typically requires a credit score minimum of 620. But FHA loans may be offered to borrowers with a credit score as low as 580! At this threshold, people who have bad credit can make changes in their financial habits that could mean the difference between renting and owning.
Buying a House With Bad Credit
Although it may take a little work to find the best fit, getting a house with bad credit is possible.
While bad credit doesn’t have to be the thing that keeps you from owning a home, it is a financial reality that can make working through money matters more complex than they need to be.
As you search for a mortgage with bad credit or a hard money loan, be sure that you are also taking responsibility for your bad credit score and do everything you can to move the needle higher.
Keep your credit card usage low, avoid opening up new credit when you can, and always pay your bills on time.
Doing these things over time will, without question, turn your bad credit into good credit. Building good financial habits will prepare you for the multiple responsibilities that come with owning a home.
References:
https://www.zillow.com/mortgage-learning/bad-credit-home-loans/
https://www.statista.com/statistics/184902/homeownership-rate-in-the-us-since-2003/
