If you’re tired of throwing away your hard-earned money on rent each month, you may be ready to buy a home of your own and begin building up equity. Unfortunately, buying a home can be a serious challenge when you’ve got bad credit. You may be plagued by mortgage denials and extremely high interest rates on the mortgages for which you are approved. Before you decide to be a lifelong renter, however, understand that there are options for turning your dreams of homeownership into reality.
What Are the Challenges of Buying a Home With Bad Credit?
There are many factors a mortgage lender will look at when determining if you’re qualified for a home loan. Of course your annual income and debts are crucial, but your credit score is also one of the most significant factors. Typically, applicants with great credit scores (750 or higher) will have the easiest time not only getting approved for a mortgage, but also getting approved for the most competitive interest rates on the market. The applicants with credit scores below 650 may have a difficult time getting approved for a mortgage in general, let alone securing low prime interest rates. (You can view your credit score for free on Credit.com.)
It’s all about calculated risk for the mortgage lender. Those with higher credit scores are perceived to be at a lower risk of foreclosure or defaulting on their home loans. As a result, they’re able to secure lower interest rates and more favorable terms on their loan. Unfortunately, those with bad credit scores are automatically perceived to be a higher risk for the lender and therefore pay higher interest rates and have to agree to less appealing terms.
What Are Some Home-Buying Options for Poor or No Credit?
If you’re thinking about trying to buy a home in the near future, the first step you should take is finding out where your credit stands. Begin by looking at your current credit report and carefully reviewing it. Specifically, be on the lookout for any mistakes or errors on your report. If you notice something incorrect on your report, you can file a dispute (most reporting bureaus, such as TransUnion, allow you to easily file a dispute online) and get it resolved before you continue the home-buying process. You should also take the time to calculate how much of a mortgage you can reasonably afford before applying for one.
If you have poor credit (a score of 650 or below), you’ll want to research home loans for bad credit. The good news is there are plenty of programs designed for first-time home buyers, such as Federal Housing Administration (FHA) loans specifically made for those who need help buying a home with bad credit. FHA loans have some of the most lenient qualification requirements available, as borrowers with credit scores as low as 580 are approved so long as they can place a minimum 3.5% down payment on a home. FHA loans don’t always require two years of employment as one of the potential qualifications.
Another program to consider is the HOPE program, which allows borrowers with bad credit to get approved for a mortgage with as little as a 0% down payment. This option is great for those with poor or no credit because it also helps to build your credit history as you begin making repayments.
Besides applying for FHA and HOPE loans, there are some ways to increase your chances of getting approved for a mortgage with bad credit. For example, you might consider saving up for a larger down payment, which reduces the amount you need to borrow and thus increases your likelihood of getting approved for a mortgage. If you’re able to put down 20% or more on your new home, you’ll save a significant amount on your interest down the road because you’ll be borrowing less money. You may also be able to avoid the need for Private Mortgage Insurance (PMI) this way, which can easily save you $1,000 per year or more. This solution frees up more money so you can pay down other debts, thus improving your credit.
Buying a home with bad credit isn’t impossible. If you take advantage of the home loans that are available to you, and do enough research to know you’re getting the best interest rates, you’ll be able to buy a house and possibly build your credit while paying your mortgage.
This article has been updated. It was originally published January 20, 2017.