Buying a house is always complicated – determining what you can afford, securing a helpful real estate agent, finding the right house, edging out the competition, obtaining a mortgage . . . Buying a house with bad credit is even more challenging, but it can be done. To better understand how your credit affects your ability to buy a house, please scroll down. We will also explore your options for obtaining a mortgage and how you can improve your credit score to obtain a lower interest rate.
Buying a House with Bad Credit
What Is Bad Credit?
As Time.com explains, your credit score is kind of like a grade point average, but it measures your credit-worthiness instead of your academic achievement. The most commonly used credit score is the FICO credit score, which runs from 300 to 850. Typically, scores of 740 or more are considered excellent, and scores of 650 or lower are considered problematic.
Why does your credit score matter? Banks, insurance firms, landlords, and even some employers use credit scores to judge how well people can manage their money. Those with higher scores are rewarded with lower interest rates; this means that borrowing money costs them less. If they qualify at all, individuals with low credit scores will be offered higher interest rates, so borrowing money is more expensive.
What determines your credit score? According to myFico.com, your credit score is calculated using information from your credit report. FICO calculates your score based on the following factors:
- 35% of your score is determined by your payment history
- 30% of your score is determined by the amounts you owe
- 15% of your score is determined by the length of your credit history
- 10% of your score is determined by the amount of new credit
- 10% of your score is determined by your credit mix
Strategies for Buying a House with Bad Credit
If you are interested in buying a house with bad credit, we encourage you to talk things through with a qualified financial professional. While they can provide welcome insight about the pros and cons of various paths forward, the first step in deciding how to proceed often comes down to a simple choice. You can try to obtain a mortgage with your existing credit or work to improve your credit before applying for a home loan.
Obtaining a Mortgage with Bad Credit
Federal Housing Administration (FHA) loans are a popular choice for people buying a house with lower credit scores. Designed to make it easier for those with less-than-stellar credit to qualify for a mortgage loan with a competitive rate, FHA loans require borrowers with a credit score of 580 or more to have a down payment of 3.5 percent to be eligible. However, borrowers with lesser scores may still be eligible if they can produce a 10 percent down payment. However, just because you meet the qualifying credit score does not mean that the loan will be approved. Many lenders have higher minimum credit score requirements.
For veterans, VA home loans are another option to consider. VA loans are loans from various lending institutions that are guaranteed by the Department of Veterans Affairs. Technically, VA loans do not have a minimum credit score and many do not require a down payment. While lenders have various standards, and most have a credit score that they’d like to see, they are often more willing to issue VA home loans to people with low credit scores because of the protection afforded by the VA’s backing (source).
Improving Your Credit
How does your credit score affect your mortgage rate? Generally, the lower your credit score, the higher the interest rate that you will be offered.
Your interest rate can make a big difference in the total purchase price of your new home. In fact, an interest rate that is even a few points higher can add thousands of dollars to your cost over the course of the repayment period. That means that taking steps to improve your credit score before applying for a home loan can really pay off in the long run.
Fortunately, credit scores are not locked in stone. While a lower score reflects the fact that you’ve made a few financial stumbles, demonstrating that you are financially responsible can gradually bring your credit score up. Forbes offers several suggestions for anyone wishing to improve their credit score, including the following:
- Review your credit reports for errors and dispute any mistakes.
- Make it a habit to pay current bills on time.
- Pay any outstanding bills, including those sent to collections.
- Reduce your debt-to-credit utilization ratio to 30 percent or less by paying down your existing balances or asking for increases in your credit limits.
- Keep existing accounts open; closing them will impact your debt-to-credit utilization ratio.
- Avoid opening new accounts, because any new credit affects your credit score.
Buying a house with bad credit isn’t impossible. While a low credit score makes it more difficult to qualify for a home loan and more expensive to borrow, there are several programs that prospective homeowners can explore. Alternatively, taking some time to repair your credit and increase your credit score can expand your borrowing options and reduce the costs involved. Which option is right for you?
If you’re ready to buy a house and you live in the Kansas City area, contact PrimeLending today. Our team is committed to helping you navigate the home financing process, so that you can purchase the home of your dreams. At our branches located throughout Kansas City, we can help you explore our wide variety of loan products and programs. Plus, PrimeLending utilizes delegated underwriting, local appraisers, and cutting-edge technology to accelerate the underwriting and closing processes. When you’re ready to learn more, please give us a call at 844-701-5626. We would be happy to help.