Even if you have a credit score as low as 580, you can qualify for plenty of first-time home buyer programs and government-backed mortgages designed for homeowners who have trouble securing a conventional mortgage. But there are also several ways you can get back on your feet in order to qualify for a traditional mortgage with a reasonable rate. Consider working with a financial advisor if you want to take this route.
Buying a Home With Bad Credit
Want to save yourself a lot of headaches while trying to find a loan? Get to know what different mortgage options are available to you. Getting preapproved for a conventional loan is a step in the right direction, but you need to consider all of the alternatives. Many government-backed loans, for example, are designed for people with less-than-perfect credit.
As with any major financial decision, planning ahead of time is of paramount importance. Be sure to research all of the options below, as well as any others you might stumble across, before making a final decision.
Homebuying With Bad Credit: FHA Loans
The Federal Housing Administration (FHA) backs loans designed for low-income Americans with less than stellar credit. Most people can secure FHA loans with credit scores as little as 580. You can borrow up to 96.5% of the home’s value from an FHA-approved lender. This means you’d typically have to make a small down payment of 3.5%.
And because the federal government backs these loans, traditional mortgage lenders tend to be less stringent when it comes to FHA loan qualification rules. In some cases, you can secure an FHA loan with credit scores between 500 and 580 as long as you can make a down payment of at least 10%.
Homebuying With Bad Credit: USDA Loans
The United States Department of Agriculture (USDA) also supports mortgages for low-income Americans without the best credit scores. USDA loans are designed for potential homebuyers looking to set their roots in designated rural and suburban areas across the country. However, many locations fall near metropolitan hubs. And despite the name, you don’t need to work in the field of agriculture to get a USDA loan.
USDA loan requirements vary based on several factors such as your income and area. But people can secure USDA loans with little or no down payments and low interest rates. Why so generous? The USDA guarantees these loans via participating lenders. Thus, lenders take less risk issuing these loans to people with low income or bad credit. You may have to take out mortgage insurance if you qualify for little or no down payment, however.
Homebuying With Bad Credit: VA Loans
If you served in the military and are seeking to own a home, the Department of Veteran Affairs (VA) can help you make that a reality. VA loans are issued by private mortgage lenders, but partially backed by the VA. So, lenders may impose more favorable requirements for securing one.
Those eligible for VA loans include service members, retired service members and certain surviving military spouses. The VA also supports the Native American Direct Loan (NADL) program.
VA loan requirements can vary, but service members can secure mortgages with no down payments, low interest rates and no insurance requirement.
Homebuying With Bad Credit: City & State Programs
Cities and counties throughout the country sponsor first-time homebuyer programs helping residents buy their first home even if they don’t make too much money or have bad credit. In several cases, having not owned a primary residence in the last three years makes you a first-time homebuyer.
So it helps to search for homebuyer programs on local government websites, as these have varying requirements.
Some initiatives such as the Good Neighbor Next Door Program support specific public servants such as police officers, fire fighters and school teachers.
But if you want to secure a conventional loan with a low mortgage interest rate, there are plenty of ways you can improve your credit score and boost your savings.
Understand and Review Your Financial Reports
Before shopping around for a mortgage, you need to know where you and your credit history stand. While it may not be fun, you have to know just how bad your bad credit might be. Things like multiple late payments, delinquencies, collection accounts, civil judgments and bankruptcies make for major red flags for lenders. It helps to know beforehand what lenders will see when they look at your credit.
You can get a free copy of your credit report from each of the major credit reporting agencies at AnnualCreditReport.com. Once you’ve got the reports, you’ll need to go over them carefully to look for errors or inaccurate information. If you find something that you think is wrong, you need to initiate a dispute with the credit reporting agency.
You can initiate a dispute by sending a written notice that includes your name, contact information, the account name and number you’re disputing, the amount of the dispute and the reason why you believe the information is incorrect. Once the agency receives your letter, they’ll have 30 days to investigate your claim. After the investigation is complete, the credit reporting agency will notify you of their findings. They will remove or update any inaccurate information as necessary.
Going over your credit with a fine tooth comb can be time-consuming. But it pays off if you can eliminate any negative information. Even something as simple as removing an incorrectly reported late payment can give your credit score a major boost. That way you can look more appealing to lenders. You don’t want to have bad credit by accident.
Pay Down Your Debts
If you owe thousands of dollars on a car loan or in credit card debt, banks may still see you as too much of a risk. This can happen even if you don’t have bad credit. Calculating your debt-to-income ratio is an easy way to find out if you’ve got too much debt.
To figure out your ratio, add up all of your debt payments. Then divide that sum by your net monthly income. If you’re shelling out 40% or more of your income each month towards debt, then you probably shouldn’t add a mortgage into the mix.
If you have a lot of debt compared to your income, you should try to work on paying it down. Getting rid of your highest-interest debts first will save you money, but it may take you longer to get debt-free. Try kicking the smallest balances to the curb first. This can boost your credit by creating a wider margin between your balances and your overall credit limit. The more you can pay down, the quicker you should see your credit start to improve.
Build Up Your Savings
Having a sizable down payment isn’t necessarily a requirement for getting a mortgage. But it definitely helps. While you’re working on repairing your bad credit, you should also be working on building up your savings account.
Saving shows lenders your responsible habits with your money. It also shows that you have the means to cover your mortgage should an unexpected financial crisis arise.
Most financial experts agree that a 20% down payment is appropriate, but that may not be feasible for you. You should try to save as much as you can before applying, but don’t kick yourself if you fall short. Having some money in the bank is better than nothing. Besides, it’s guaranteed to grow as long as you stick with it.
The options for potential homebuyers with bad credit don’t end there, though. You may want to look into lease-to-buy programs, loans from private lenders or financing through the seller. There are further assistance programs for low-income home buyers like HUD or Habitat for Humanity as well. If you’re really serious about owning a home of your own, it pays to leave no stone unturned. Don’t let bad credit keep you from getting a mortgage.
Tips for Homebuyers
- Finding a way to fit mortgage payments into your financial plan can be a grueling task, but you don’t have to go in it alone. Consider working with a financial advisor for this. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Keep shopping around and compare mortgage rates before you agree to take out a loan to buy your first home. Don’t forget this likely will be one of the biggest financial decisions you will ever make.
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