Buying a House With Bad Credit: What to Consider
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For many of us, buying a house is the heart of the American dream. Whether this means a modest single-family home, a condo unit or a waterfront mansion, homeownership offers a chance to establish roots. Buying a house is also one of the most important financial transactions you’ll ever make, but for those with bad credit, it can be a real challenge. Here is a look at some of the financial issues facing aspiring homeowners with bad credit.
Unless you are paying cash, you will need to obtain a mortgage to purchase your home. One of the most important metrics a prospective lender will look at is your credit score. Minimum credit scores required vary depending on the type of mortgage you’re applying for:
- Conventional loans: 620
- FHA loans: 500
- USDA loans: 580
- VA loans: There is no stated minimum, but your whole financial profile will be evaluated.
Borrowers with credit scores below the minimum may not qualify for these types of loans, or may face higher interest rates or be required to make a higher down payment. Mortgage lenders want to lend money, but they prefer to lend to borrowers who are likely to make the required payments.
Lenders may view your low credit score as an indication that you may not be able to make timely loan payments, do not manage your finances responsibly or carry a high debt-to-income ratio. These may or may not be fair characterizations, but a poor credit history will impact your ability to obtain a mortgage, or the cost of that mortgage if you can obtain one.
What should you consider when shopping for a lender?
If you have bad credit, you may have to search harder than others to find a willing lender. Before trying to figure out which lender is right for you, take some time to assess the depth and severity of your own problems.
“First, you have to determine just how bad your credit is,” said Casey Fleming, a mortgage adviser with C2 Financial Corporation and author of “The Loan Guide: How to Get the Best Possible Mortgage.” A credit score from an online source or a credit report may not tell you everything you need to know, he said. “You have to work with a competent, ethical mortgage adviser to get an assessment of which issues can be fixed, which cannot and what actually matters.”
Fleming also stresses that not all credit issues are created equal. Your credit score is an indicator of how likely you are to default on the loan. Negative credit events, such as a bankruptcy or a prior foreclosure, will limit your loan options regardless of your credit score. Whether working with a mortgage professional or doing this on your own, it’s important to understand your credit issues and to seek out a lender that is equipped to work with a borrower in your situation.
Are there alternative lenders to consider?
These days, there are many alternative lenders that will consider home buyers with damaged credit:
- FHA, VA and USDA loan programs. Government-backed programs such as FHA, VA and USDA loan programs are run by the government to encourage homeownership among groups that might not qualify under conventional loan guidelines. FHA loans are insured by the Federal Housing Administration. VA loans are geared toward military service members, veterans and qualifying spouses. USDA loans are a program of the U.S. Department of Agriculture.
- Credit unions. Credit unions are owned by their members. Many credit unions are essentially affinity institutions. For example, Navy Federal Credit Union is open to military service members, veterans and their families. Credit unions don’t usually get into subprime loans, but they often look beyond an applicant’s credit score. They may look at a borrower’s overall profile, including their assets, their history of repaying debt, their earnings and their cash flow.
- Online lenders. Online lenders are a growing group, and they vary in terms of their credit score requirements. So, it can pay to shop around, and the ease of online access makes this relatively easy. Online lenders will also vary in terms of their customer service and ease of use.
- Mortgage marketplaces. Mortgage marketplaces are online lead generators for mortgage lenders. They match borrowers with various lenders that might be a good fit based on your creditworthiness. This can be a solid avenue for borrowers with poor credit. If this option sounds right for you, try LendingTree.
- Mortgage brokers. In the case of a borrower with poor credit, an experienced mortgage broker can help you assess your situation and match you with potential lenders that might be a good fit for borrowers with your credit profile. It is important to understand whether the broker has an affiliation with any particular lender to help ensure that you get unbiased advice.
Should you try to fix your score before applying for a mortgage?
Beyond applying for a mortgage, it’s always a good idea to try to fix your credit score. Here are some steps you can take:
- Check your credit report for errors. These can and do occur, and you should monitor what’s in your report on a regular basis. Each of the three major credit bureaus is required to provide a free copy of your credit report annually.
- Do your best to pay on time. Continual late payments can be a major blemish on your credit history. Payment history makes up 35% of your FICO Score.
- Keep balances low. The amount owed accounts for 30% of your credit score.
- Open new credit accounts carefully. The amount of new credit you pursue makes up about 10% of your credit score.
In the end, if you think you can increase your credit score quickly, you may want to delay seeking a mortgage. But the thing to remember is that you always have options. Be careful not to take out a mortgage that you will struggle to pay back, which could further damage your credit score and weaken your financial profile. Owning a home may be the American dream, but it’s not worth mortgaging your future.