With so many requirements and choices, buying a home can feel like an overwhelming process. If you have a bad credit history or unstable finances, it may seem like you don’t even have the choice to buy a home.
But don’t worry, there are many mortgage options for homebuyers with poor credit. As unreachable as a home may seem to you, you should learn about the many resources to help you. We’ll help you understand credit scores, credit risk, and the options available.
Is Your Credit Score That Bad?
You may have had trouble paying off some of your debt or have had bad luck with your credit but a good place to start is find out what your credit score is. It may not be as bad as you think and if it is, you will have gained the information you need for the first step to buying a home.
Contrary to popular belief, there isn’t a one-size-fits-all credit score minimum for a mortgage. A credit score is just a general indication of your credit risk. Different loans and lenders will have different requirements, but here are some general guidelines to give you a frame of reference.
- Above 620: Your credit score is perfectly fine. With this credit score, you qualify for most conventional loans and you almost definitely qualify for government-insured loans like VA loans, USDA loans, or FHA loans. If your credit score is above 740, you are doing very well and could probably get the best mortgage rates and terms.
- 500-620: Your credit score isn’t ideal but you definitely have options. Most conventional loans look for homebuyers with credit scores of at least 620 but government-insured loans have lower requirements. These mortgages also have relatively lower mortgage rates.
- Below 500: Generally, this is considered a low credit score. You may find it difficult to find a mortgage and might need to co-sign it with someone else like a family member or spouse. You should try improving your credit score before trying to taking out a mortgage.
Unless your credit score is absolutely amazing, improving your credit is always a good idea. Even if you have the minimum credit score required for your best option, you could get the best mortgage rates if you improve your credit score, which could save you thousands of dollars.
Your Credit Score Isn’t All That Matters
Everyone talks about your credit score like it is the sole determinant of what loans and homes you can get, but that’s not the case! Your credit score is just a starting point for lenders to make a general risk assessment. Lenders look at many factors which include your:
- Down Payment Capabilities: Loans typically have a minimum down payment requirement but it’s always better to have more available for a larger down payment. Not only could you improve your options and mortgage rate, but you could also buy a more expensive home by paying the difference between the mortgage amount and home price out of your own pocket.
- Other Debt Obligations: A mortgage is a large debt obligation that will add a monthly mortgage payment. Lenders will use your Debt to Income (DTI) ratio as an indicator of your current debt obligations and a high DTI could disqualify you from getting a mortgage on its own. Generally, a DTI of less than 36% is considered good, but government-insured loans will accept DTIs of up to 41% (43% for FHA loans).
- Current Income: A credit score is an indicator of your past creditworthiness but you might have gotten a promotion, a new job, or some other new inflow of cash. When lenders evaluate you for a mortgage, they care about your ability to make payments. If you can prove that you are a low-risk borrower using your income, you can get better mortgage rates and more options.
- Lender: Your lender is extremely important. Unless you’re getting a specialized mortgage with preset rates and terms, your mortgage rate and conditions depend heavily on the lender you choose. Most loans allow lenders to set their own mortgages and can vary between people even if they have similar finances. When deciding to get a mortgage, you can greatly help yourself by speaking with different lenders.
- Mortgage Type: There are many mortgage options available depending on your credit, income, classification, and even the location of your home! With the same credit score and the same lender, you could get very different rates and conditions depending on the mortgage type. There is no such thing as the “best loan” because many mortgages and mortgage programs serve different purposes.
What Mortgages Can You Get with Bad Credit?
Now that you know where you stand and what mortgage lenders consider, it’s time to pick the best mortgage for you. This largely depends on you and can change with your financial situation.
The first place to look is at your state’s local housing authority. Each state has its own unique mortgage programs that can help make the homebuying process easier. These programs are generally targeted toward first-time homebuyers, veterans, and homes within federally designated target areas.
If you’ve looked into your state’s local options and can’t find what you need, the federal government has programs that create federally-insured mortgages with lower mortgage rates and requirements, which include:
- Conforming Loans: These loans are mortgages that meet the minimum requirements according to the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). They typically have lower requirements for income, credit score, and minimum down payment while still having competitive mortgage rates. The HomeReady program only has a minimum down payment requirement of 3% and the HomePossible program has low-interest rates, minimal down payment requirements, and no credit score requirement.
- FHA Loans: FHA Loans are mortgages insured by the Federal Housing Administration (FHA). FHA Loans are good for first-time homebuyers with lower incomes or limited savings available for a large down payment. However, even if this describes you, a conventional loan may still be the best option and it is important to understand the differences. If your credit score is between 500 and 620, this mortgage is a great option. They limit their mortgage terms to either 15 or 30 years but have competitive mortgage rates even beating out most private loans.
- VA Loans: VA Loans are mortgages insured by the United States Department of Veterans Affairs (VA). If you’re active military personnel or a qualified veteran, and you meet the minimum requirements, in most cases, this loan would be your best choice. VA Loans don’t have minimum credit score requirements but you should still aim for a score of at least 620 for a better chance of being approved. These loans have low mortgage rates, no mortgage insurance premiums, and no minimum down payment requirement.
- USDA Loans: USDA Loans are mortgages insured by the United States Department of Agriculture (USDA). If you are looking to purchase a home in a rural area and have moderate to low income, this loan is ideal. These loans have no minimum credit score requirements at all and no minimum down payment requirements. The only downside is that these loans only have mortgage terms of 30 years but their mortgage rates are just as competitive as other federally-insured loans. If you have poor credit or trouble improving it, these loans are perfect for you.
By now, you hopefully understand that having bad credit doesn’t eliminate your chances of owning a home. Without improving your credit, there are still several options available but don’t rush.
If your credit is below 500, even if you can get a mortgage, you might be stuck making a 10% down payment. And if your credit score is below 740, it’s still worth it to improve your credit to get those first-class mortgage rates. Your key takeaway should be that getting a mortgage is far from impossible. But this would probably be the largest investment of your life, so you should take the time to do it right.