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Tips for First-Time Homebuyers With Bad Credit

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If you’ve made past mistakes or experienced a life event that resulted in financial distress and a low credit score, homeownership isn’t necessarily out of reach. You may qualify to become a first-time homebuyer with bad credit.

A “bad” credit score falls somewhere between 300 and 579 on the FICO credit scoring scale. Your credit score is just one of the many factors that mortgage lenders scrutinize when determining whether you’re eligible for a home loan. The good news is there are homebuying programs available to help make getting a mortgage with bad credit a possibility.

8 tips for first-time homebuyers with bad credit

  1. Review your credit reports
  2. Speak with credit and housing counselors
  3. Meet with a lender
  4. Rebuild your credit history
  5. Pay down debt
  6. Increase your income
  7. Make a larger down payment
  8. Have an emergency fund

Home loans for bad-credit first-time buyers
What to expect when buying a home with bad credit

8 tips for first-time homebuyers with bad credit

First-time homebuyers with bad credit or FICO scores below 580 often face more challenges than buyers with good or excellent credit, but there are steps that may help demonstrate your creditworthiness as a potential borrower.

1. Review your credit reports

Order your free credit report from each of the three major credit reporting bureaus (Equifax, Experian and TransUnion) at AnnualCreditReport.com. Scan each report for errors and negative factors that could be impacting your credit score. Each bureau has instructions for disputing incorrect information.

2. Speak with credit and housing counselors

A housing counseling agency approved by the U.S. Department of Housing and Urban Development (HUD) can help you navigate the homebuying process. You can receive free or low-cost advice to help you:

  • Prepare a budget for your home purchase
  • Identify available homeownership assistance programs
  • Learn how to complete a mortgage application

A nonprofit credit counselor can help you come up with a plan to better manage and pay off your existing debt. Having these measures in place can improve your chances of a loan approval. For a small fee or no charge, you can get help creating a budget and developing a plan to get out of debt.

3. Meet with a lender

Even if you’re not quite ready to apply for a home loan, familiarize yourself with loan options and receive individualized advice on how to get a mortgage by speaking with a mortgage lender.

If one thing holding you back as a first-time homebuyer with bad credit is a limited credit history, ask about possibly using on-time rent and utility payments to beef up your credit profile. Lenders can also provide guidance on what bills to pay down to help boost your score more quickly.

4. Rebuild your credit history

One of the best ways to improve your credit history and score is to pay every bill on time. Your payment history accounts for 35% of your credit score. Keeping old credit accounts with zero balances open can also improve your credit score. Slowly apply for new credit — if necessary — so you don’t appear to be taking on too much debt all at once.

5. Pay down debt

Paying down your credit card balances and working to eliminate other non-mortgage debt like auto or personal loans can help you get a low-credit-score mortgage.

You may see an improvement in your credit score by keeping your credit utilization ratio below 30%. This means you use less than 30% of your available credit limit on each credit card at a given time. Additionally, having fewer or reduced monthly debt payments helps your debt-to-income (DTI) ratio, which is the percentage of your gross monthly income dedicated to repaying debt. Mortgage lenders typically like to see a total DTI ratio, which includes your monthly housing payment and all other debts, at or below 43%.

6. Increase your income

You can pay down debt and save for a down payment faster if you pick up a side hustle, or perhaps overtime hours at your full-time job. This extra income may also lower your DTI ratio and help you qualify for a mortgage. Your job history is an important indicator of financial stability to lenders, so it’s crucial to have at least a two-year history of consistent, full-time employment.

7. Make a larger down payment

You can compensate as a first-time homebuyer with bad credit by making a larger down payment. Doing this may assure your lender that you’re less likely to go into mortgage default, since you have more skin in the game than a borrower with a smaller down payment. In addition, a bigger down payment will lower your monthly mortgage payment amount, because you’re borrowing less money.

8. Have an emergency fund

While paying down debt and saving for your down payment are important, perhaps most essential to your financial well-being is building and maintaining an emergency fund. Having a healthy savings account with at least three to six months’ worth of your living expenses demonstrates your financial strength to a lender and prepares you for unexpected homeownership costs.

Home loans for bad-credit first-time buyers

Every loan program and lender has slightly different standards, so shop around. Consider the following options for first-time homebuyers with bad credit.

Loan program  Minimum credit score  Minimum down payment 
Fannie Mae HomeReady® loans  620 3%
Freddie Mac Home Possible® loans  660 3%
FHA loans  500 10% with a 500-579 credit score;

3.5% with 580+ credit score

VA loans  620 0%
USDA loans  640 0%

Fannie Mae HomeReady loans. HomeReady loans have a minimum 620 credit score requirement. It’s important to note, however, that you’ll need a minimum 25% down payment with that score. In order to make the minimum 3% down payment, you’ll either need a minimum 680 or 720 credit score, depending on your DTI ratio. You must also meet income limits set by Fannie Mae.

Freddie Mac Home Possible loans. If you have a 660 credit score or higher, the Home Possible mortgage program gives you the option to buy a house with a down payment as low as 3%. Home Possible loans are also an option for borrowers without a credit score due to a limited or nonexistent credit history. Similar to Fannie’s HomeReady program, income limits apply.

FHA loans. Guaranteed by the Federal Housing Administration (FHA), FHA loans are available to borrowers with a credit score as low as 500, provided they can make a 10% down payment and meet other lending requirements. Borrowers with a 580 credit score or higher may qualify with just a 3.5% down payment.

VA loans. If you’re a military service member, veteran or eligible spouse, a home loan backed by the U.S. Department of Veterans Affairs (VA) can be a viable option. VA lenders typically require a 620 credit score, but may make an exception for slightly lower scores. You won’t have to pay for mortgage insurance or make a down payment.

USDA loans. The U.S. Department of Agriculture (USDA) guarantees USDA loans, which typically require a minimum 640 credit score. While there’s no down payment requirement, you must meet income eligibility requirements. Additionally, the home you’re buying must be located in a USDA-eligible rural area.

What to expect when buying a home with bad credit

Bad credit may not stop you from qualifying for a homeownership program, but it could make the process more difficult — and more expensive. Here’s what you may encounter:

  • You’ll face more scrutiny. Your credit score is meant to indicate to lenders the likelihood that you’ll repay your loan. Lenders will want to know why you’re a first-time homebuyer with bad credit in the first place. Providing clear explanations for your financial difficulties — such as a previous job loss or foreclosure — may work in your favor when compared with someone who routinely overspends and makes late payments.
  • Your interest rate will likely be higher. Lenders may reserve the lowest mortgage interest rates to homebuyers with a minimum 740 credit score. The lower your credit score, the higher your mortgage rate. This also means you’ll likely pay more in interest over the life of your loan.
  • You may have a higher-cost home loan. Lenders can charge “overlays,” which are additional fees or higher rates imposed on borrowers with a low credit score, unusual circumstances or who are buying a property that may be considered a risky investment.
  • You may have to pay higher mortgage insurance premiums. If your down payment is less than 20%, you’re required to pay for private mortgage insurance on a conventional loan. Mortgage insurance premiums are required for most FHA loans, no matter the down payment amount. Mortgage insurance rates vary by credit score and other factors.
 

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