How To Buy a House With Bad Credit: 5 Tips To Get Your Mortgage Application Approved
Your credit history is one of the most important factors lenders consider when deciding whether to approve you for a mortgage loan to purchase a home. Would-be borrowers with bad credit can have a tough time getting a loan, but it might be possible to be approved despite a low credit score.
What Is the Minimum Credit Score To Buy a Home?
Exact credit score requirements vary by loan type and lender, but the following guidelines will give you a good idea of what to expect:
- Conventional loan: 620
- Jumbo loan: 700
- VA loan: No minimum imposed by VA, but lenders usually require a minimum score of 620
- FHA loan: 500 with 10% down payment; 580 with 3.5% down payment
- USDA guaranteed loan: No minimum imposed by USDA, but lenders usually require a minimum score of 640
Good To Know
Your credit score isn’t the only credit factor that affects your mortgage application. You’ll also need a recent history of on-time payments. It’s better to have a lower score with no late payments in the last 12 months than to have a higher score with recent late payments, according to Gustan Cho of Gustan Cho Associates Mortgage Group.
How To Buy a House With Bad Credit
You can make yourself a better credit risk in the eyes of potential lenders by setting the numbers up in your favor.
1. Plan To Pay at Least 20% Down
A sizable down payment increases your stake in homeownership and reduces the risk that you’ll default on your loan. Putting down at least 20% also lets you avoid mortgage insurance, which protects lenders in case borrowers default but adds a monthly premium to your mortgage payments and costs you extra at closing, according to the Consumer Financial Protection Bureau.
2. Build Up Cash Reserves
You’ll want to save up at least two months’ worth of home payments, including principal, interest, taxes and insurance, but some lenders require as much as six months’ worth for riskier borrowers. Cash reserves include bank accounts, stocks and bonds and vested funds in retirement accounts and life insurance policies — money you can withdraw quickly in a pinch.
3. Lower Your Debt-to-Income Ratio
Mortgage lenders want you to have a lower debt-to-income ratio because you’re more likely to fall behind on mortgage payments if you’re already juggling other debts. To determine your DTI ratio, add up your monthly debt payments and divide that number by your gross monthly income. The CFPB recommends a DTI ratio of 43% or less, but a ratio of 36% or less gives you the best chance of being approved for a loan.
4. Get a Second Job
A side gig will strengthen your mortgage application by increasing your income and decreasing your DTI.
5. Lower Your Loan-to-Value Ratio
The LTV ratio is your mortgage loan amount divided by the appraised value of the home you’re buying. The lower the LTV, the less risky the loan will seem to the lender, as you’ll have more equity in your new home. Keep your LTV low by hunting for good values and making the largest down payment you can afford.
Home Loan Options For Buying A House With Bad Credit
Even if you have poor or bad credit, you still might quality for these loan options to buy a house:
- Conventional Loan: This loan doesn’t require minimum income, credit score or down payment to qualify. However, the minimum credit score required to qualify for a conventional mortgage loan is usually 620 or higher. If your income is high or you put a large down payment, you might still be able to qualify, even with your score being lower than 620.
- FHA Loan: Backed by the Federal Housing Administration, many first-time homebuyers might consider applying for this loan option for their lower qualifying requirements. Having at least a 500 on your credit score is needed to getting this loan, with a10% down payment. If your score is 580, you’ll need to put down a 3.5% down payment. The only disadvantage to this loan is that you’ll be paying for mortgage insurance.
- VA Loan: If you’re a veteran, member of the military, or married to someone who is serving, then you can qualify for the VA loan program. No down payment is requirement to buy a home, however some lenders may charge you a one time “funding fee”.
- USDA Loan: This loan is backed up by the U.S. Department of Agriculture. With a credit score of 640 or higher, you might qualify if you’re wanting to buy a house in a rural area with a zero down payment.
How To Improve Your Credit To Get a Better Mortgage Rate
If your credit score is low due to financial mistakes you’ve made in the past, your goal should be to boost it so you can not only qualify for a loan but get a competitive interest rate as well.
Here’s what you can do to improve your credit score:
- Review your credit report for errors: If you find errors, contact all three credit bureaus with the proper documentation to correct them.
- Pay bills on time: Paying on time is one of the best ways to improve your score.
- Pay down debt: Paying down debt, starting with accounts in collection, will reduce your DTI and might increase your credit score.
The Bottom Line
Buying a home with bad credit can be difficult — but it’s not impossible. Boost your credit by trimming debt, cleaning up your credit report and saving up a big down payment plus cash reserves.
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- Gustan Cho Associates. 2021. "Mortgage With Good Credit But Recent Late Payments."
- U.S. News & World Report. 2021. "What Credit Score Do You Need to Buy a House?"
- Capital One. 2021. "What Credit Score Is Needed to Buy a House?"
- Fannie Mae. 2020. "B3-4.1-01, Minimum Reserve Requirements (10/07/2020)."
- Fannie Mae. 2020. "B3-6-02, Debt-to-Income Ratios (02/05/2020). "
- Select. 2020. "What credit score is required to buy a house?"
- American Financing. "Mortgage Reserves & Assets Needed to Buy a Home."