How To Buy A Home With Bad Credit
Buying a Home With Bad Credit
Having a bad credit score does not immediately disqualify you from buying a home. Although it is a little more difficult to qualify for a mortgage with a below average score, it is not impossible. Fortunately, you have several options to choose from if your credit is less than stellar or worse. However, keep in mind it will cost you more over the life of your loan than someone who has good credit. Here are some of the many options available that will help you buy a home.
Federal Housing Administration
Also known as the FHA, this government agency helps low-income individuals with bad credit buy a home. In many cases, the FHA will help you if your credit score is as low as 580. The agency is popular among first-time homebuyers since it allows down payments as low as 3.5 percent of the purchase price. If your credit score is lower than 580, the FHA lone requires a 10 percent down payment. Remember though that the lower your credit score, the higher your interest rate.
Important Facts About the FHA
Many people think the FHA provides the actual funds to purchase a home. The truth is, the FHA only insures the loan in the event you default on your mortgage. A bank or lending institution actually issues the loan. However, banks or mortgage companies will typically follow the FHA's guidelines for qualification to protect themselves in the event you default on your loan.
The FHA also has additional requirements if your credit score is low. For starters, you must pay private mortgage insurance. Known as PMI, this insurance is an additional form of protection lenders require when you make a down payment that is less than 20 percent. Additionally, you must have a strong work history or worked for the same employer for at least two years. The FHA has several other requirements, including a total debt-to-income ratio of not more than 43 percent, and you can only use the loan for a primary residence if you are using the FHA for the first time.
Save for a Bigger Down Payment
The cold hard facts are numbers rule your life, and there is no better example how numbers rule than in the mortgage industry. If you cannot make a 20 percent down payment or your credit score is lower than 580, then you can expect some challenges to buying your ideal home. Real estate company's can help, but almost all home loans require a bigger down payment, and most lenders want a minimum of 20 percent.
The saying "patience is a virtue" is so true in the mortgage industry. If you can take the time to save a minimum down payment of 20 percent, you will open up so many doors, even with bad credit. Whether you have bad credit or not, a 20 percent down payment definitively tells lenders that you have the resources and the ability to handle a mortgage. A bigger down payment also gives you instant equity in your home and lowers your loan-to-value (LTV) ratio. A larger down payment is also a signal to lenders that you are less likely to default on your monthly payments.
A Little About Your Credit Score
You might think that your low score will prevent you from qualifying for a mortgage. However, do not write yourself off completely, and take a little time to learn what goes into a credit score and why it is so important. Here are some facts about your credit score:
- All mortgage lenders use the FICO credit scoring model. Although this may change in the future, FICO is the predominant score in the home loan market. Learn what you can about what goes into a FICO score and how to improve your score.
- There are five key areas that impact your FICO score: payment history (35 percent), the amount of debt you owe (30 percent), length of your credit history (15 percent), credit mix (10 percent) and new credit (10 percent).
- FICO credit scores range from 300-850. If your credit score is 850, then you have perfect credit. If your credit score is 300, then you have a long way to go before you can qualify for a mortgage. According to the credit scoring agency Experian, the average credit score in the United States is 687. Most lenders consider any score above 720 as excellent. If you have a 640 credit score, lenders consider it fair. Any score below 640 puts you in the subprime borrowers' category. Although it is not necessarily a bad score, which is anything below 580, it can create borrowing challenges.
Every lender in the U.S. has their own interpretation of what is good or bad credit. From home loans to car loans, credit scores are only a part of the lending puzzle. Sometimes things happen that are outside of your control and it adversely affects your credit score. Lenders who offer home loans will more than likely work with you if you have some dings on your credit report that hurt your score. Additionally, a professional real estate agent can help you eliminate some of the mortgage qualifying headaches if your credit is less than stellar. Remember, bad credit is not a borrowing death sentence.