In May 2021, the median price for a home was $350,300. That reflected a 23% increase year-over-year, demonstrating that the housing marketing was bustling after the impact of the COVID-19 pandemic. But it’s not just a rise out of the pandemic that has created a competitive housing market in 2021 and beyond. The record high in May 2021 followed 111 months of year-over-year gains, starting in March 2012. 

In 2021 and 2022, the housing marketing has been awash in demand. But there aren’t enough homes to go around, leading to bidding wars and other challenges for buyers. Looking at this landscape, you may wonder, can you buy a house with bad credit?

• The Challenges of Buying a Home with Bad Credit
• How to Buy a House with Bad Credit
• Know Your Credit Score

The Challenges of Buying a Home with Bad Credit

Mortgage lenders look at a lot of factors to determine if you qualify for a home loan. Of course, your annual income and debts are crucial, but your credit score is also a significant factor. Applicants with great credit scores—750 or higher—tend to have an easier time getting approved for a mortgage and getting the most competitive interest rates available. Applicants with credit scores below 650 may have a more difficult time getting approved for a mortgage or securing low interest rates.

For a mortgage lender, all applicants present some sort of calculated risk. Lenders perceive those with higher credit scores as being at lower risk of foreclosure or defaulting on their home loans. As a result, people with high scores can get a lower interest rate and more favorable terms on a loan. Unfortunately, those with bad credit scores are automatically perceived to be a higher risk and—if they can get a loan—may end up paying higher interest rates and having to agree to less appealing terms that come with a bad credit mortgage.

COVID-19’s Impact on Buying a Home

The pandemic had some impact on the mortgage-buying process. That’s true for individual buyers as well as the entire process.

Homebuyers may have faced financial struggles during the pandemic, for example. Job or income loss could have led to difficulties paying bills or the need to take out loans to cover living expenses short-term. Those situations can impact credit and your ability to get a home loan.

At the same time, the Federal Reserve dropped interest rates in 2020 to help support the struggling pandemic economy. One result was that buying a house became very attractive, in part due to the lower overall cost of the loans.

Bad Credit in a Competitive Market

But now rates are increasing again—and may continue to rise throughout the year. Increasing rates may decrease competition between buyers, but they can make it more difficult for someone with less-than-great credit to buy a home for a number of reasons, including:

• You may not be able to outbid others. Lenders may be willing to take a risk on someone with poor credit, but that risk is usually fairly limited. That means you may not be able to get approved over a certain amount, limiting how much you can pay for any home.
• Your loan options may limit you. Buying a house with bad credit often means leveraging a government-backed loan, such as FHA or USDA loans. These loans must follow certain requirements about loan-to-value ratios, inspections and other steps to buying a home. In today’s housing market, having to stick to strict requirements can put you at a disadvantage.
• Sellers may not choose your offer. Even if your offer is competitive, if you’re bidding with an FHA loan or other such financing, sellers may opt for a cash offer or one backed by a traditional commercial loan. Right or wrong, there’s some perception that cash or traditional loan offers are more likely to go through.

How to Buy a House with Bad Credit

It’s not all a lost cause, though. There are options for buying a home with poor or bad credit, such as Federal Housing Administration (FHA) loans. That’s true even in a competitive market.

FHA Loans

FHA loans have some of the most lenient qualification requirements. And they’re available to any homebuyer, not just first-time buyers. 

To be eligible for an FHA loan, you need a credit score of at least 500. You’ll also have to meet other requirements, including appropriate debt-to-income ratios and not having certain types of open collection accounts in your credit history. Overall, you need to demonstrate to the lender that you’re reasonably able to pay the mortgage associated with the loan.

If you have a credit score between 500 and 579, the loan-to-value ratio is limited to a maximum of 90% on any FHA loan you might be approved for. That means you’ll need to come up with at least 10% of the purchase price as a down payment. For example, if you buy a home for $200,000, you’ll need at least $20,000 for the down payment.

If you have a credit score of 580 or above, you could be eligible for maximum financing. That means you may be able to get a loan with as little as 3.5% down.

VA Loans

Veterans Administration loans are available to military veterans and qualified spouses. The VA doesn’t set a specific credit score requirement for its programs, though it does state that borrowers will need to meet creditworthiness requirements. At the very least, the lender must determine that you have the means to pay the mortgage. 

Some benefits of VA loans include:

• They don’t necessarily require a down payment
• No requirement for PMI, even if you don’t put down 20%
• Competitive interest rates you might not be able to access elsewhere

USDA Loans

The United States Department of Agriculture offers mortgages to home buyers in eligible rural areas whose incomes fall in the low-to-average income range for their areas.  The USDA doesn’t publish a minimum credit score requirement. It simply states that borrowers must have the willingness and ability to repay the loan, as demonstrated in part by their credit history. USDA lenders must look at three years of credit history.

Other Options

There are ways to increase your chances of getting approved for a mortgage with bad credit, even if you don’t want to go with one of the above government-backed options. Consider saving up for a larger down payment. A larger down payment reduces the amount you need to borrow and increases your likelihood of getting approved for a mortgage. 

You may also be able to avoid the need for Private Mortgage Insurance with a higher down payment. Bypassing the need for PMI can easily save you $1,000 per year or more. It also frees up more money so you can pay down other debts, which can improve your credit.

Know Your Credit Score

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 reports and carefully reviewing them. 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 credit bureaus let you file a dispute online. You should also take the time to calculate how much of a mortgage you can reasonably afford before applying for one.

If you’re not sure what your credit score is, you can see your credit score for free on Credit.com. You also get a free credit report card that shows you ways to improve your credit score in each of the five areas that factor into how your score is calculated.

For even more information about where your credit stands, consider signing up for ExtraCredit®. You’ll get access to 28 of your FICO® scores, including the type of scores used by lenders to evaluate you as a mortgage borrower. 

Once you know where you stand with your credit score and have done what you can to improve it, you can start shopping for mortgage rates and loans.

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