Buying a house with bad credit is possible, but it will likely end up costing you extra money in the long run.
Unlike traditional mortgages, which require a good credit score to qualify, loans that are available to those with lower credit scores typically have higher mortgage rates. But if home ownership is your goal, it’s definitely possible to achieve it with some concessions.
If you’re a first-time home buyer, there are programs designed to help you qualify for a loan. To start, it helps to understand what you’ll need to do to buy a house.
How to buy a house with bad credit
1. Get copies of your credit report
Understanding your credit history is key to understanding what’s affecting your credit score. Your credit report features details like your personal information, your payment history, and whether you’ve filed for bankruptcy. Getting your credit report can help you figure out any discrepancies so you can report errors, pay off debts, and boost your score.
You’re entitled to a free credit report from all three major credit bureaus every year. Go to AnnualCreditReport.com to find out more.
2. Consult a housing counselor
Speaking with a housing counselor from a HUD-approved agency can help you understand different parts of the home-buying process, such as lending options and how to close on a house, and how your credit score will factor in.
Typically, these are free or low-cost meetings; the goal is to help you understand the nuances of becoming a homeowner. You can search on HUD.gov for HUD-approved housing counseling agencies in your state.
3. Start saving for a down payment
Saving for a down payment will show lenders you’re serious about buying a house. Those with bad credit should consider setting aside a larger down payment, as it could help you get a better mortgage rate.
A larger down payment shows the lender that you are more invested in purchasing a home, since you put more money down. While there are mortgages that accept down payments of 3.5%, aiming for higher is best.
4. Review your housing budget
Understanding how much you can realistically afford will help you manage your housing costs. It’s not only the mortgage you need to worry about — there are taxes, insurance, home maintenance costs, and potentially HOA fees if you’re purchasing a condo.
Don’t forget there are also closing fees, which you’ll pay when you close on your house, as well as moving costs. If you’re unsure of how to work out estimated costs, ask your housing counselor.
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5. Apply for an FHA or lower-credit-score loan
Unfortunately, with a low credit score, the mortgage you qualify for will likely come with a higher interest rate, which means you’ll end up paying more interest throughout the lifetime of the loan. Still, shopping around for mortgage rates, options, and terms is a good idea. Speak to your mortgage broker or housing counselor about your options.
Another option is to look into an FHA loan, which comes from a traditional mortgage lender and is insured by the Federal Housing Administration. You may be able to qualify for an FHA loan with a minimum credit score of 580 and a 3.5% down payment. However, not all lenders will approve you, as some have higher credit score requirements.
Taking out an FHA loan does mean that you’ll need to pay mortgage insurance, also known as a mortgage insurance premium, throughout the lifetime of your mortgage. Mortgage insurance benefits the lender because it insures against the chance that you stop making payments on your loan. Currently, the mortgage insurance premium on an FHA loan is 1.75% upfront, then 0.7 to 0.85% annually.
You can also look into VA loans if you are a veteran — the VA doesn’t set a minimum credit score, but lenders typically prefer borrowers with at least a 620 score. The same is true for USDA loans, which are available to some borrowers in rural and suburban areas, though lenders tend to prefer borrowers with a score of 640 or higher.
6. Work on rebuilding your credit
If you find that you can’t qualify for a loan, you’ll want to take steps to become more creditworthy. Review your credit report again to see what is impacting your credit score, then take steps to improve it. Consider decreasing your debt-to-income ratio by increasing your income, paying off debts, or both.
Consider using credit monitoring tools — there are free tools, some provided by your credit card issuer — so you can keep track of your credit score and figure out when it’s time to apply for a home loan.