If you’re tired of renting, you may be ready to buy a home of your own and begin building up equity — rather than throwing away your hard-earned money on rent each month. Unfortunately, if you have bad credit, buying a home can be a serious challenge. You may be plagued by mortgage denials and extremely high interest rates on the mortgages for which you are approved. Before you resign to being 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 different factors a mortgage lender will look at when determining your qualification for a home loan. Of course, your annual income and debts are two major factors, but your credit score is one of the most significant. Typically, applicants with great credit scores (740 or higher) will have the easiest time not only getting approved for a mortgage, but getting approved for the most competitive interest rates on the market. Those 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 two of free your credit scores, with updates every 14 days, on our site.)
It’s all about calculated risk: 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 loan terms overall. Unfortunately, those with bad credit scores are automatically perceived to be a higher risk for the lender and therefore pay in higher interest rates and other 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 exactly where you stand in terms of your credit score. Begin by pulling a free copy of your current credit report and carefully reviewing it. Specifically, be on the lookout for any mistakes or errors on your report. If you notice anything incorrect on your report, you can file a dispute (most reporting bureaus, such as TransUnion, allow you to file a dispute easily online) and make sure to 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 a mortgage.
If you have less-than-ideal or poor credit (a score of 650 or below), then you’ll want to begin exploring options regarding home loans for bad credit. The good news is that there are plenty of first-time home buyer programs, such as Federal Housing Administration (FHA) loans, that are specifically designed for new homebuyers and those who need help buying a home with bad credit. Specifically, FHA loans have some of the most lenient qualification requirements available, with borrowers with credit scores as low as 580 being approved as long as they can place a minimum 3.5% down payment on the home.
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 to 3.5% down payment. This is a great option for those with poor or no credit at all, as it also helps to build your credit history as you begin making repayments.
In addition to FHA and HOPE loans, there are other ways to go about increasing 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. 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 frees up more money for you to pay down other debts and thus improve your credit.
It’s important to understand that having poor credit doesn’t have to mean missing out on the benefits and joys of homeownership. By taking advantage of home loan options available to you and shopping around for the best interest rates, you can secure a home loan with reasonable terms and fulfill your dream of owning a home.