Buying a House With Bad Credit? Here’s What You Need to Know

Credit scores are crucial little numbers that play a key role in your financial health. With a good credit score, you’ve got many more doors open to you in the financial world, including having an easier time getting approved for home loans with favorable interest rates and terms. But a bad credit score can have the opposite effect.

Unfortunately, about one-third of scorable Americans have bad credit, which can be the result of any number of things. The thing is, conventional mortgage lenders prefer to work with borrowers who have good credit, as they will be less likely to default on their mortgages and leave lenders scrambling to foreclose the property and sell to recoup their investment.

While lenders look at several factors before approving an applicant for a home loan, credit scores play an important role and can be the one thing that can result in a rejected mortgage.

If you’ve got bad credit and are trying to get a mortgage to purchase a home, you might be out of luck with conventional lenders. However, you might be able to get approved for a home loan if you seek out alternatives to traditional mortgage products.

Know Your Score

Before you even start applying for a mortgage, be sure to find out exactly where your credit score stands. You can do this by pulling your credit report from one of the three major credit bureaus: Equifax, Experian, and TransUnion. Once you know what your credit score is, you’ll know where you stand, since your credit score will affect whether or not you can get approved for a home loan as well as what interest rate you’ll be offered.

Conventional loans typically require a credit score of at least 620. Any lower than this will make it much more difficult, if not impossible, for you to get approved for a traditional home loan.

Consider Working With Bad Credit Lenders

There are many alternative lenders who work with clients with bad credit scores. Such lenders place more weight on other factors when they considering home loan approval aside from credit scores, including the following:

  • Income
  • Type of employment
  • Savings
  • Down payment amount

If all of the above factors are strong, they may be enough to compensate for your bad credit score and make it easier for alternative lenders to agree to provide you with a mortgage. Your credit might not necessarily be strong, but if your income and savings can make up for it, lenders may be more willing to work with you.

More specifically, a hefty down payment can be the factor that seals the deal for lenders. Not only does a higher down payment amount reduce the amount of money you would have to borrow and lower your loan-to-value ratio (LTV), it also shows lenders that you have the financial strength to afford a mortgage and the payments that come with it. Besides, lenders may even require that down payments are at least 10% to 20% of the purchase price of a home in order to reduce their overall risk.

It should be noted that mortgages from alternative lenders typically come attached with higher interest rates than you would be offered by your bank or other traditional financial institution, especially if your credit score is low. Generally speaking, the lower your credit score, the higher your interest rate because of the inherent risk that lenders are assuming by extending credit to low-credit borrowers.

Look at Home Loans Designed For Borrowers With Bad Credit

If your credit score is less than 620, there are still ways to get approved for a mortgage thanks to loan options designed with bad credit borrowers in mind. A very popular mortgage product among borrowers with bad credit are FHA loans, which can be qualified for with a score as low as 580.

Not only may you be eligible for an FHA loan with a low score, but the down payment requirements are lower than conventional mortgages as well. While a 5% minimum down payment is required for traditional mortgages, FHA loans require as little as 3.5%.

Thanks to the low credit score and the low down payment requirements of FHA loans, these mortgage products tend to be quite popular among first-time homebuyers who may be just starting to build credit and saving for a down payment. These programs also provide the benefit of allowing the entire down payment amount to be gifted from a family member or friend.

The Bottom Line

Just because you have bad credit doesn’t mean you have to kiss your dreams of homeownership goodbye. While the process may certainly be more challenging, getting mortgage approval doesn’t have to be impossible. That said, it’s in your best interests to take steps to improve your credit score.

If time is on your side, take measures to give your score a boost right now so that you’re in a better position to get approved for a mortgage at more favorable rates in the near future. If not, there are still avenues you can take to get a mortgage, despite your bad credit.