When you’ve got bad credit, the dream of buying your own home can seem like just that — a dream. But thanks to programs designed to help more Americans become homebuyers, you could be in luck.Here’s what it takes for first-time homebuyers with bad credit to make their dreams come true.
A look at credit scores
Before we dive into the options for folks with bad credit, you’re probably wondering what credit score qualifies as “bad” vs. “good.” Lenders typically break credit down into three categories using a FICO credit score, a number that’s based on several factors, including your payment history and the longevity and types of your credit accounts:
- Excellent credit: a score of 660 or above
- Fair credit: a score between 580 and 660
- Bad credit: a score below 580
So where does your credit fall? If you don’t know your number, you can find out for free. You can also check your full credit report from all three major credit bureaus once every year for free, through AnnualCreditReport.com.
What to expect as a first-time homebuyer with bad credit
If your credit score falls below that 580 number, you can expect it will be a bit tougher to find a lender, said Nathaniel Butler, marketing manager for Falls Church, Va., lender Washington Capital Partners.
“While it doesn’t bar you from securing a loan outright, it means that the property deal that you present to the lender must be so incredible/profitable that it mitigates the added risk of a bad credit history,” Butler said. Hard money lenders like Butler are private entities (separate from a bank) that lend based off of a hard asset (for example, the real estate value itself).
In other words? It’s tough, but not impossible. Here are some hurdles you might be facing:
- Higher interest rates or origination points paid at closing: These will make the buying process much more costly, as banks put more financial burden on buyers with bad credit. “These are both tools that lenders use to mitigate the additional risk of lending to an individual with bad credit,” Butler said.
- Larger down payments: Low credit scores affect the loan-to-value (LTV) ratio you can qualify for, said Jesse Gonzalez, broker of record at North Bay Capital in Santa Rosa, Calif. That means a lender will only finance so much of the property, leaving the rest up to the buyer to contribute out of pocket in order to buy the property.
- Down payment financing options: If you can’t come up with a larger down payment, some buyers may be able to use private mortgage insurance (PMI) to reduce the amount a lender asks for upfront. According to Evan Wade, co-founder and partner of Philadelphia Mortgage Brokers, PMI is often less expensive than buyers think, and the premium can often be bundled into a mortgage payment so buyers have just one bill to pay each month.
Is buying a home the best option now?
When to buy a home is a personal decision, no matter what your credit score is. As Wade said, “I would never try to force someone into buying a home if they feel they’re not ready yet.”
But there are some factors that buyers with poor credit should keep in mind:
- Buying vs. renting: Average rents and home prices vary by location, but buying now could end up saving you money as you build equity by owning your home. To figure out whether you might save by buying, the Federal Home Loan Mortgage Corp. (also known as Freddie Mac) offers a rent vs. buy calculator.
- Should I rent and rebuild credit? Putting off a home purchase gives a buyer time to clean up their credit, Butler noted, which might end up saving them money in the long run. After all, a higher credit score might give access to loans with lower interest rates and fewer fees.
- Rising interest rates: Take a peek at the market. If interest rates are low, it might be a reason to buy now, while you can save a little cash. If interest rates are climbing, it will affect any mortgage you might get, Wade said.
Mortgage loan programs for first-time homebuyers with less-than-stellar credit scores
There’s no question that it can be a tougher road to homebuying for people with bad credit, but there are options designed for folks in exactly that situation. The Federal Housing Administration (FHA), for example, offers a loan that’s available to buyers with a score as low as 500, and other programs are available. Let’s take a look at some of the programs out there with federal backing:
- FHA loan — Insured by the FHA but granted by private lenders, FHA loans are some of the most forgiving of bad credit, Gonzalez said, offering loans to folks with scores as low as 500. LTV requirements vary from 65% to as high as 90%, depending on a borrower’s score, and these loans do require PMI. Bonus? The FHA makes loans available for mobile and manufactured homes as well.
- VA loan — Designed to help veterans of the U.S. military as well as Active Duty servicemembers and some eligible spouses and beneficiaries, VA loans are insured by the U.S. Department of Veterans Affairs (VA). These loans carry no credit score requirements and require no down payment for eligible borrowers, unless it’s required by the private lender approved by the VA to make the loan.
- USDA loan— The U.S. Department of Agriculture (USDA) helps make loans available for low- and very low–income buyers who cannot access a mortgage via other means (such as being denied due to credit score). These loans typically do not require a down payment; however, buyers should be aware that USDA loans are limited to purchases in areas designated as rural by the agency.
- Home Possible® Mortgage — Buyers with bad credit or no credit score at all may be able to find help via the Freddie Mac Home Possible Mortgage program. These loans, designed for low- and moderate-income buyers, have down payment requirements as low as 3% for some buyers.
- Good Neighbor Next Door: If you’re a law enforcement officer, teacher, firefighter or emergency medical technician, you might be able to qualify for this U.S. Department of Housing and Urban Development (HUD) program that’s open only to people in these particular fields. The program cuts the sales price of HUD homes by as much as 50%, and allows buyers to use a federally backed or conventional loan to buy the home. The program does require you have PMI and that you live in the home for at least three years.
Other lending help for first-time homebuyers
Buyers with bad credit may also be able to find help via local and national programs designed to make homeownership a reality for more Americans.
Local housing authority: Depending on where you live, you may be able to find help from a local housing authority to finance your first home. Programs are available around the country, designed to help buyers with budgeting, planning and, of course, accessing loans. Find a housing authority near you.
How to improve your chances of getting approved for a mortgage
If you’ve taken a look at your credit score and you’re feeling glum about your chances, there may still be some things you can do to get a mortgage as a first-time homebuyer with bad credit.
- Find a co-signer/co-borrower. If a friend or family member has better credit and will agree to vouch for you, they may be able to help you secure a loan, Gonzalez said. “I’ve seen loans denied by the automated underwriting system (AUS) that will become approve/eligible simply by adding a co-borrower, even if the co-borrower is non- occupying.”
- Put up a bigger down payment/find a loan with low LTV ratio. If you’ve got the cash to put down or a friend or family member is willing to chip in, a lender may look more favorably on you as a borrower, Gonzalez said. Because the lender didn’t front 100% of the cost of the property, it can fall back on the remaining value financed to recoup their losses, should you default. You will likely still face higher interest rates, but at least you’ll have a loan.
- Build up a savings account. Borrowers want to see that you have the financial means to pay off your loan in the long run.“You need to properly maintain a budget to ensure you’re able to stay in your home and not face foreclosure or bankruptcy,” Wade explained. Building up savings signals to lenders that you have the budget to pay your mortgage each month.
- Improve your score. Lenders are humans too, and they often want to help out prospective first-time buyers. That can even mean giving tips on how to improve your credit score. “We have methods with our credit reporting agencies to do a ‘what if’ scenario on your current credit report,” Gonzalez explained. “We punch in a desired credit rating and the scoring model will tell us what we need to do with the credit in order to obtain that higher score.” The lender can tell the borrower a few things to do to improve his or her credit, and the system will do a rapid rescoring of the report in as little as a few days.
- Get credit errors fixed. One tip that often helps to improve your score? Getting errors on your credit report fixed. Is a loan that you’ve paid off showing up as in arrears? Did someone steal your Social Security number and open a credit card in your name that hasn’t been paid off? You can open a dispute directly with the credit reporting agency to have the faulty information removed and your score recalculated.
Before you start drooling over real estate photos, it’s important to take a hard look at your credit. If things look grim, it’s OK. Find out what you can do to fix it, or talk to a lender about the programs designed to help folks in your situation.