Buying A House With Bad Credit

the escrow process

You might think that having a credit score in the 500s would keep you from buying a home. But that isn’t always the case.

Depending on your circumstances, you may have lending options that make it possible to overcome that bad credit barrier when buying a home. This guide will teach you how to buy a house with bad credit, and where to go to find financing that will work for you.

What Credit Score is Needed to Buy a Home?

The minimum credit score you need to buy a home will vary based on a few factors:

  1. The type of mortgage you want
  2. The lender you’re asking
  3. Who you are

Minimum Credit Score Needed for Different Mortgages

Certain types of home loans allow you to qualify with a lower credit score while others require a higher score.

  • Traditional fixed-rate loans typically require a minimum score of 620 to qualify
  • Adjustable-rate mortgages (ARMs) require a minimum score of 600
  • FHA loans backed by the U.S. Federal Housing Administration require a minimum score of 580 if you make a down payment of 3.5%
  • FHA loans with a 10% down payment only have a minimum requirement of 500

So, if you have the capital to make a 10% down payment on the house you want, you may be able to buy a home even with a 500 credit score. You just need to find the right lender, which leads us to the next factor…

Lender Credit Score Requirements

Every lender has a set minimum credit score they require to approve homebuyers for a mortgage. Some lenders will accept lower credit scores while others have stricter requirements.

For example, a big national lender may approve a homebuyer with a 620 FICO for a fixed-rate mortgage. However, a smaller local bank might require a minimum score of 700 to qualify for a mortgage with them.

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    This means you need to look for the right lender if you have a lower credit score. Online lenders, big national banks, or credit unions may all offer more flexible score requirements. As a homebuyer with bad credit, be prepared to shop around.

    Also, be aware that lenders may change their requirements depending on the economy. There are certain times that lenders may be more flexible about approving a loan for a homebuyer with bad credit. During economic slowdowns, lenders may tighten up their credit score requirements, making it more difficult to qualify. During a strong, stable economy, they’ll relax those requirements.

    VA Loans’ Credit Score Requirements

    Your personal situation may also come into play when it comes to getting a mortgage with bad credit. The best example is VA loans, which are backed by the U.S. Department of Veterans Affairs. VA loans have no minimum credit score requirement.

    They also have no down payment requirement. That means as a Veteran or Military Service Member, you can buy a house with bad credit with no money down, assuming you can find the right lender.

    While the VA itself has no minimum score or down payment requirements, lenders that provide VA loans may still have those requirements. However, the minimum credit score requirement for any VA loan will typically be much lower than the requirement for any other loan from the same lender.

    First-time homebuyers can also generally find more flexible credit score requirements through certain programs, like the HomePath Ready Buyer through Fannie Mae and HomeOne lending program through Freddie Mac. It’s important to note that both programs can also work for homebuyers that have owned previously, as long as you haven’t owned a home in three years or more.

    Another example of how your circumstances can make it easier to buy a home with bad credit is if you are a member of a credit union. Credit unions often have lower credit score requirements, but they may have even more flexibility for actual members.

    So, What’s The Secret to Buying a House With Bad Credit?

    No matter what your circumstances are, there is one surefire way to find all the opportunities available to you to buy a house with bad credit. All it takes is one free phone call and a quick consultation with a HUD-certified housing counselor.

    Housing counselors are a little-known resource that anyone can take advantage of anywhere in the U.S. They provide free information and one-on-one confidential counseling to homebuyers, and they know all the local programs, lenders, and services that are available in your area.

    Why You Need a Housing Counselor

    The U.S. Department of Housing and Urban Development (HUD) approves nonprofit financial counseling organizations to provide housing counseling. Counselors go through extensive training, learning about federal, state, and local programs that help homebuyers achieve the dream of homeownership.

    Housing counseling agencies are local, meaning they are approved to provide counseling in a specific state and region. That hyper-local focus means they know every avenue available to help homebuyers out. Thus, in one consultation with a housing counselor, you can learn about any option you have in your area that helps bad credit homebuyers get approved.

    So, if you want to buy a home with bad credit, the first step is to call a HUD-certified housing counselor in your area. There may be a few extra steps after that, depending on your situation. We’ll describe each one in more detail now.

    First-time Homebuyers

    Several federal programs help first-time homebuyers that have bad credit. Some banks also offer first-time homebuyer programs. And remember, that you don’t need to be a first-time buyer to use these programs. Many first-time homebuyer programs apply to anyone that has not owned a home in at least three years.

    So, whether it’s your first time buying or just your first time in a long time, here are the steps you take to buy a home with bad credit:

    1. Find a housing counselor in your local area. The Consumer Financial Protection Bureau (CFPB) offers a helpful tool that lets you search for housing counseling agencies by zip code.
    2. Call for a home buyer consultation. Let the counselor know you are a first-time homebuyer that has bad credit. They’ll review your finances with you and may ask to check your credit. Don’t worry, this is a soft credit pull so it won’t affect your score.
    3. Learn about the options available to you. The counselor will explain programs that you can qualify for where you want to buy. These programs will have low minimum credit score requirements. They may also offer low or no down payment amounts. There may also be programs to provide down payment and closing cost assistance.
    4. Take a first-time homebuyer course. Many first-time homebuyer programs require you to provide a certificate of completion for a HUD-approved first-time homebuyer course. You take the 8-hour course, which may be in person or online, and receive a certificate of completion. This certificate is good for up to one year.
    5. Create an action plan with your counselor. Your housing counselor will help you create an action plan so you can get ready to buy a home. Together, you’ll set a budget and map out the steps you need to take to become mortgage-ready.

    Veteran Homebuyers

    If you’re a military Veteran, Service Member, or surviving military spouse, then you have an advantage as a homebuyer with VA home loans. The VA does not place any lending requirements on the loans that they insure. There is no minimum credit score requirement and no down payment requirement.

    That means in the right circumstances and with the right lender, you can buy a house with no money down and bad credit.

    Step 1: Contact the right people to find the right VA loan

    In this case, there are several organizations you can reach out to that will help you find the loan you need:

    Any of these organizations will be able to put you in touch with the right people and programs to get a loan, despite any bad credit and down payment challenges you may be facing.

    Unlike with first-time homebuyer programs, there are typically no extra hoops that you need to jump through to qualify for a no-money-down bad credit VA loan. You just need to know lenders in the area that have the best terms. All of the organizations listed above should be able to help you find those.

    Step 2: Get your COE

    Qualifying for a VA loan requires a Certificate of Eligibility (COE), which you can apply for online. You will need certain documentation to prove your eligibility. This differs for Veterans, Service Members, and surviving spouses. If you are a member of the National Guard or Reserve, you will need certain documentation, depending on if you are active or discharged, and if you have been activated or not.

    Step 3: Contact the lender or mortgage broker

    Once you have your COE, you can contact lenders that provide VA loans in your area and start shopping for the right loan.

    Lenders should be able to share if they have any credit score or down payment requirements on VA loans upfront. You shouldn’t need to apply to find out if you can qualify with a particular lender. It may be a good idea to just talk to each lender before you apply to see if they’d be willing to work with you.

    Keep in mind that credit bureaus will treat mortgage applications made within a two-week period as just one inquiry. This allows you to shop around and find a lender that offers you the best rate without driving down your credit score. That’s important because while you can get approved for a mortgage with bad credit, the interest rate will be much higher. That brings us to our next point…

    Should you buy a house with bad credit?

    Now that we’ve gone over all the options that may help you buy a house with bad credit, let’s focus on whether you should take these options and run with them.

    While there are plenty of lending products that offer mortgages to people with bad credit, they all have one thing in common—higher costs. The interest rate on a mortgage for someone with bad credit will be much higher than the interest rate for someone with good credit. The monthly payments will be higher and so will the total cost of financing your home.

    So, for example, a Veteran with bad credit can qualify for a VA loan because there’s no credit score requirement. But their costs to buy a home and their monthly mortgage payments will both be higher than the same VA loan for a Veteran with good credit.

    This makes it crucial to consider your situation carefully and decide if it’s worth waiting to improve your credit before you buy. If you can take six months to build your credit while you’re building up savings for a larger down payment and building a budget to support you as a homeowner, you’ll be in a much better position.

    This is something you should discuss with your HUD-certified housing counselor in your free homebuyer evaluation. They can help you review your credit and create steps to improve it as part of your home buying action plan.

    Then, once you complete that action plan, your credit and finances will be in a much better state to apply for mortgages. You can take two weeks to shop around without hurting your credit, find the best loan, and get pre-approved by the mortgage lender. These are all steps that you want to take regardless of your credit score, but they’re even more critical when your score is low. So, as a final note on this, let’s look at the fundamental steps that any home buyer should take when buying a home.

    Essential Steps to Take

    The steps you take to buy a home with bad credit are the same steps that anyone should take when buying a home. These steps increase your chances of getting approved for a mortgage, as well as having your offer accepted. That’s more important than ever, given how competitive the homebuying market is these days. You have to compete against cash buyers, investors, and other people like you that are just looking for a good home. The more you prepare, the more likely you are to succeed.

    With that in mind, in order these are the steps you should take to buy a home:

    1. Find a HUD-certified housing counselor in the area where you want to buy your home.
    2. Get a free financial evaluation to learn about lending options and mortgage assistance programs that may be available to you.
    3. Create an action plan so you can become mortgage-ready.
    4. Once you follow those steps, start shopping for a mortgage. Take two weeks to apply and compare rates from lenders.
    5. When you find the best mortgage for your needs with the lowest interest rate, ask the lender to provide a mortgage pre-approval letter. You will want this letter when you start shopping for a home.
    6. Also, work with the lender to set up an escrow account. Put some of your down payment savings into the account immediately to set up earnest money. This is 1-2% of the purchase price of the home you will want to save in escrow. Having earnest money shows sellers you are a serious homebuyer.

    Having a mortgage pre-approval letter and earnest money will give you the best chances of having an offer accepted when you buy a home. Sellers and their agents will understand that you’re a serious buyer that can make a serious offer on a home.

    Your pre-approval letter will also help you narrow down your home search. That’s why it’s good to shop for your mortgage first, then start shopping for a home. You’ll know exactly how much home you can afford to buy.

    Be Smart About Shopping for a Home

    Once you have all these ducks in a row, now you’re ready to start the actual homebuying process. You can start looking for your dream home. If this is your first time buying, getting a Realtor® or a real estate agent can be immensely helpful.

    A good agent can help you:

    • find homes that fit your needs
    • make offers
    • negotiate the best price and terms with the seller

    You can do all that on your own, but it can be difficult if you’ve never gone through the process before. Even if you have gone through the process, having an agent can make the home buying process smoother and less stress-inducing.

    Once you reach an agreement with you’re the seller on the price, you’ll contact the mortgage lender. They will start finalizing your mortgage agreement and you’ll be on your way to closing!

    Prepare for the Costs of Homeownership

    One final tip is that during the homebuying process and up to closing, you want to make sure you’re prepared for the costs of being a homeowner.

    This is something most people underestimate. You’re used to having a landlord or property manager that fixes things when they break. That’s all on you as a homeowner. You’ll have to find repair techs you can trust and make sure things get fixed to your satisfaction.

    As a homeowner, you also want a more robust emergency savings fund because home repairs can get expensive. Many major repairs, such as replacing your water heater or major appliances or fixing your heating or air conditioning unit can run a few thousand dollars a pop. And it’s a homeowner’s luck that most things usually break at the same time.

    So, make sure you set a budget to be a good homeowner even before you get to closing day. Put added savings in at the beginning to build your emergency fund and give you a little extra something for decorating after you first move in. This will help ensure you have the best possible experience once you become a homeowner.