How to Buy a House with Bad Credit

Buying a home is one of the most exciting steps you can take, and it’s within reach even if your credit isn’t perfect right now. Millions of people with less-than-stellar scores become homeowners every day, and with the right plan, you can too.

Understanding what lenders look for in terms of credit and the other factors they consider when weighing your application could boost your chances of success. If your bad credit is debt-related, enrolling in a debt relief program could also help. 

Freedom Debt Relief isn't a credit repair organization and doesn't provide or offer services or advice to repair, modify, or improve your credit.

What Credit Score Is Considered Bad for Buying a House?

Every lender has their own way of defining good and bad credit. Generally, credit score ranges break down like this:

Source: Experian.

Several factors affect your credit score, including your payment history and how much you have charged to your credit cards. A bad credit score often happens because you have too much debt. This could mean missed payments and charging more to your credit card than you can pay back at the end of the month. Everyone's situation is different.

You could still buy a house with bad credit or fair credit, though you may have to make a larger down payment or hunt around to find a lender willing to work with you. Typically, the minimum credit scores needed for common types of home loans are:

• Conventional mortgage: 620

• FHA home loans: 500 (with 10% down payment) or 580 (with 3.5% down payment)

• USDA loans: 580

• VA loans: 620

It's up to creditors to decide who they want to lend to. If you're not sure whether your credit score is high enough, you can always ask the creditor about minimum score requirements on mortgages.

If your credit score is too low to qualify for any mortgages right now, you could take steps to increase your score before you apply. This might include exploring debt relief options. The following five steps will guide you through the process that could get you to homeownership.

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1. Check Your Credit Report for Errors

Some errors in your credit report could reduce your credit score, making it harder to borrow money when you need it. Here’s how to correct the mistakes. 

The first step is to get your free credit reports from annualcreditreport.com. You’re entitled to get these every week. You'll need to answer some questions to verify that you're you. Then, you'll be able to view your reports from each of the three credit bureaus: Equifax, Experian, and TransUnion. These reports provide details about your history of borrowing money, including open loans and credit cards.

It's best to check all three as they are likely to differ at least a little. Credit bureaus don't share information with each other. Mortgage lenders will look at all three reports when considering your mortgage application. 

Check your reports for anything that seems off, like:

• Incorrect personal information. This could be a wrong address or an incorrect middle initial. That might be a clue that the credit bureau has confused you with someone else and is reporting their information on your report.

• Accounts that aren’t yours. This could be a sign that your identity was stolen and someone may be racking up charges in your name.

• Closed accounts reported as open. This could make it appear as if you have more debts than you do.

• Duplicate accounts. This could make it appear as if you're overextending yourself by borrowing more than you are.

• Misrepresented payment history. Late payments can really hurt your credit score. If one of these shows up on your report in error, it could drop your score by tens or hundreds of points.

• Outdated credit or balance information. This could also make it appear as if you've borrowed more than you did. High balances cause lenders to worry that you're spending beyond your means.

If you come across any inaccurate information you think is hurting your score, dispute it as soon as possible.You can do this by visiting the associated credit bureau's website and filling out a form. You'll need to state what information is incorrect and why you believe it's incorrect. If you have documents proving your claim—like a notice stating that a loan showing as open on your account is in fact closed— a copy to the credit bureau.

Both the credit bureau and the reporter are required to investigate the issue within a reasonable time of receiving your dispute. This usually takes between 30 and 45 days. If they find the information in your report is incorrect, they must change it. 

It takes time, but resolving these issues. Keep tabs on your credit by checking your reports at least annually and possibly more frequently if you plan to borrow money. You could also consider paying for a credit monitoring service to notify you about changes to your credit reports. 

READ MORE: 5 Ways to Improve Your Credit

2. Compare Offers From Several Mortgage Lenders

If you want to buy a house with bad credit, you'll have to spend some time researching lenders that accept borrowers with low credit scores. Most charge a higher rate to borrowers with lower scores, but that doesn't mean they'll all charge you the same rate.

Mortgages are very competitive. Lenders want your business. Start by comparing mortgage lenders online. You could also look at banks and credit unions in your area. Sometimes, you can get a lower interest rate with a credit union than you can with a traditional bank. 

You'll have a choice between several loan types. Here are some of the most popular.

Conventional mortgages

Conventional mortgages have a fixed or adjustable rate, usually a 15- or 30-year term. You can find these with just about any mortgage lender. These loans typically have stringent credit requirements, with most insisting on a 620 or better. This may not be an option for you if you have bad credit.

FHA loans

You might be directed to consider an FHA loan instead. FHA loans have lower down payment and credit score requirements than conventional loans. In fact, you could qualify with a credit score as low as 500 if you make a 10% down payment. You'll need at least a 580 credit score to qualify for the 3.5% down payment. Most private lenders are FHA-approved, so to get started all you have to do is ask whether the lender provides FHA loans. Note that not all FHA lenders accept a score lower than 580. You might have to hunt around a bit if that’s your goal.

VA loans

VA loans are only available to military members and veterans, so this may not be an option for you. If you fall into this group, they're definitely worth considering. VA loans don't require a down payment. Lenders set their own minimum credit scores for VA loans, and some may require a score of 620 to 640 or better.

USDA loans

USDA loans are low-interest mortgages available to low-income suburban and rural homebuyers. It's possible to get one of these loans with no down payment, though if you have poor credit, your lender may insist that you put something down.

USDA loans don't have a set minimum either. Again, it's up to the lender to decide. You may find some willing to work with you if you have a score of 580 or better or if you have a very low debt-to-income ratio (DTI).

Understanding DTI ratios and bad credit

In addition to your credit report, lenders also look at your debt-to-income ratio (DTI) to decide whether to work with you. This compares the amount of all your monthly debt payments to your monthly income.

Calculate yours by totaling up your monthly debt payments. This includes things like loan and credit card payments, but it doesn't include regular monthly expenses, like utilities and groceries. Then, divide this by your gross (pre-tax) monthly income and multiply by 100. For example, if you have a gross monthly income of $5,000 and monthly debt payments of $1,500, your DTI would be 30%.

For a mortgage, you want a DTI of 50% or less. Lower is better. This shows lenders that you comfortably manage your existing debt payments and possibly the addition of another loan too.

Bad credit and a high DTI often go hand in hand. Debt relief strategies, like debt settlement, could be a big help if you want to reduce your DTI and improve your financial stability. 

3. Save Up for the Down Payment

FHA loans require just a 3.5% down payment, but other lenders may require more. Have money saved before you start looking. 

If you’re struggling to save for your down payment, look for down payment assistance via grants from the U.S. Department of Housing and Urban Development (HUD). The department provides funds to each state, which then gives the funds to residents in need. Before you can get a HUD grant, you need to be approved for a mortgage and take a HUD-approved housing counseling class.

4. Get Pre-Qualified or Pre-Approved for a Mortgage

Whether you're trying to buy a home with bad credit or good credit, getting pre-qualified or pre-approved can help you understand how much house you can afford. 

Pre-qualification is easier to get. You tell a mortgage lender about your income and credit standing. They give you an idea of how much you could afford to borrow and the interest rate you'd pay. You can usually get one of these with a quick phone call to the lender or by filling out an online form. However, pre-qualification isn't a guarantee that you’ll get the loan.

Pre-approval is one step closer to the loan. It means the lender has verified your financial situation and believes you’ll qualify for the loan. For some lenders, pre-approval is a firm offer to lend. In any case, you’ll need to complete a formal loan application when you’re ready to get the loan.

A pre-approval letter is usually good for a few months after you receive it. If you buy a home during that time, and nothing in your financial situation has changed, the lender should honor the terms in your pre-approval. 

Getting a pre-approval could also help you stand out more in a competitive buying market compared to borrowers who don't have one. 

To get pre-approved, you usually have to provide proof of income, including tax returns and bank statements.

The role of co-signers in bad-credit home purchases

Home buyers with bad credit may be able to enlist the help of a co-signer to increase the odds of success. A co-signer is another person—not necessarily one of the would-be home buyers—who pledges to take over the loan payments if the homeowners fall behind on their payments. It's a big responsibility, so it's not a decision to make lightly.

How helpful it will be depends on the lender you work with and the co-signer's credit. Some lenders look at the lowest score, but others look at the median score. For example, say a married couple is shopping for a home and they enlist a family member as co-signer. The lender might take the middle of the three scores rather than the lowest. In that case, the co-signer's high credit score could give you that much-needed boost to get approved.

If you use a co-signer, everyone should be on the same page if the home buyer(s) get into difficulty. If the home buyer makes late payments, this will affect the co-signer. Communication and a good-faith effort to keep up with payments are necessary to ensure that the personal relationship between the borrower and the co-signer stays strong. 

If you're worried that asking a friend or relative to act as a co-signer could damage the relationship, it might be better to wait until you've improved your credit. Then, try applying for a mortgage yourself.

5. Find Your Home and Continue Improving Your Credit

Now it's time to get serious about finding the home you want. Submit an offer and, if it's approved, go back to your lender to complete the mortgage approval process. But don't stop there.

Focus on making all your loan payments on time. Automate your payments if possible so you don't forget to make them. Over time, on-time payments, including mortgage payments, could help boost your credit score, which may open the door to better loan terms down the road. Once you've improved your credit score, you could consider refinancing to get a lower monthly payment or pay less in interest overall. 

If you've done the steps above and you haven't had any luck trying to buy a house with bad credit, focus on improving your credit score. The best ways to start are to pay down any credit card debt and pay all of your bills on time every month. 

You could also take steps to lower your credit utilization ratio: the ratio between your credit card balances and your credit limits. This ratio is a major factor in your credit scores. You could consider taking out a debt consolidation loan or seeking debt settlement to get these expenses off your plate for good.

You'll likely begin to notice gradual improvement within a couple of months of consistent effort. Negative marks, like late payments, remain on your credit report for seven years, but their effects diminish over time. Once they fall off your report, you should notice even bigger jumps.

After you've gotten your credit score up, you can reach out to mortgage lenders to try again.

Common Mistakes to Avoid When Buying With Bad Credit

When you want to buy a house with bad credit, be sure to avoid these mistakes:

• Taking on new debt before closing. This could increase your DTI and make lenders think twice about working with you.

• Missing payments during the home-buying process. This will make lenders nervous that you might default on your loan.

• Not shopping around for your loan. Shopping around is key to finding the best possible loan terms.

• Ignoring total costs beyond monthly payments. Pay attention to how much interest you'll pay over the life of the loan, closing costs, additional monthly fees such as HOA dues, and whether there are any prepayment penalties if you decide to pay your loan off early.

• Rushing the process. You may be eager to own a home, but it takes time to rebuild your credit and find the perfect home. Rushing could mean you miss out on a better home or a lower rate.

With a little patience and determination, you could buy a home even if your credit still needs some work. Don't stop trying to improve your credit score once you've got your deed in hand. Continue to improve your credit over the months and years that follow so you'll have an easier time getting approved the next time you need to borrow money.