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6 Tips For Buying A House With Bad Credit

Posted on June 10, 2018November 23, 2022 by tiripsekud

If you’re looking to get out of renting and want to plant roots for a while, buying a home can be a great move for your life and finances. However, if you’re still working on fixing your credit, you may wonder if buying a house with bad credit is even possible!

In this article, we’ll be looking at that question. Plus, we’ll go over the steps you can take when buying a home with bad credit.

Buying a house with bad credit – is it possible?

If you’re thinking about how to buy a home with bad credit know that it may not be easy, but it can be achievable for you. You’ll just have to invest a little more time in planning and preparation before you start seriously house hunting.

That said, it is a very individual process. Buying a home with bad credit might not be on the cards for everyone. It depends on a variety of factors, including:

  • How bad is your credit is
  • Your source of income/how much/how steady it is
  • What other debts do you have
  • Whether lenders in your area are willing to work with you

In the steps below, we’ll get deeper into some of these factors and how you can use your strengths to overcome your weaknesses.

6 important steps to buying a house with bad credit

When you’re considering buying a house with bad credit, going through these steps will help you find out where you stand and what to do!

1. Pull your credit report

The first step, of course, is to find out where you’re starting from and what credit score you’re working with! Your credit score includes things like the credit-utilization ratio and payment history. You can get the most official report from AnnualCreditReport.com, but typically it’s limited to once a year for free.

It gets you a report from all three of the main credit bureaus (Equifax, Experian, and TransUnion). They all use slightly different metrics to measure your score. So you should expect a different number from each bureau, though they’ll likely be in the same general range.

There are also free services like CreditKarma to check more frequently and monitor how your score is changing. CreditKarma uses your Equifax and TransUnion scores. To help you determine your credit health, the different credit score ranges are divided into these categories:

  • Exceptional: 800-850
  • Very good: 740-799
  • Good: 670-739
  • Fair: 580-669
  • Poor: Under 580

A score in one of the top two ranges will earn you the best interest rates, while you’ll struggle more for approvals in the bottom two. The “good” range is fairly average, so you might not qualify for every offer once you hit 670. But it will give you more options.

Even though it may be frustrating to see a low credit score, it’s one of the important steps to buying a house with bad credit. Learn as much about credit as you can so you can improve yours faster.

Minimum credit score when buying a house with bad credit

How low can your score be for you to still get approved for a mortgage as a first-time homebuyer buying a home with bad credit? Typically, the minimum credit score requirement for buying a house is between 500-620 depending on the type of loan. FHA loans may allow lower credit scores in the 500 range.

2. Prepare to pay higher mortgage interest

A low credit score signals a higher risk to lenders. To compensate for that risk, any loan offers they make will typically come with a higher interest rate (e.g. a 5% annual interest rate instead of 3% with a good score).

These single-digit differences may sound small, but they add up when you consider that a mortgage lasts for 15-30 years. You can wind up with a higher monthly mortgage payment. This article has examples of how your credit score can affect your mortgage rate, and how much extra you might pay over time.

If you need to know how to buy a home with bad credit but not pay a high amount forever, there’s good news. Fortunately, even if you start out with a high-interest rate on your mortgage, it doesn’t necessarily mean you’re locked into that rate for life. You can explore refinancing your mortgage for a lower rate down the road when your credit is better.

3. Pay off your other debt

Something that can be even more important to mortgage lenders than your credit score is your “debt-to-income,” or DTI ratio. The name of this measure is very descriptive. It simply compares your total monthly debt payments to your total monthly income.

It allows lenders to get a sense of how much other debt you have. Plus what percentage of your income you can dedicate to the rest of your monthly expenses?

To calculate your own, add up your monthly debt payments (credit card payments, car loans, student loans, and the future mortgage payment you’re planning). Then divide it by your typical monthly income. Lenders prefer DTI ratios below 36%.

If you currently have a big monthly burden of other debts, plan to work on them before you pursue buying a home. Paying off your other debt looks good to lenders. And it will help improve your credit score and lower your DTI number.

After you do some of this, you may not be buying a house with bad credit, as your score could improve. Check out our article on 6 key steps to paying off debt!

4. Determine your budget

Before you start shopping around and get your heart set on a dream home that’s out of a sensible price range, sit down and determine what you can comfortably afford. This is one of the essential steps to buying a house with bad credit.

You don’t want to buy more house than you need and end up “house poor”. Which is essentially spending a high percentage of your income on your mortgage/home expenses and not having much left to save/invest/use for other expenses.

Since you’ll also probably be paying higher interest when buying a house with bad credit, it’s even more reason to buy below your means.

A good rule of thumb is to spend no more than 28% of your annual gross income on a mortgage. E.g. if you make $50,000/year, you’ll want to look for a house and mortgage that costs you a max of $14,000 per year, or approximately $1150/month.

While you don’t have to include other home-related expenses in this 28%, you should still consider them. If you’re buying a fixer-upper because it’s cheap, research how much the necessary improvements will cost. Then you’re not taken by surprise.

5. Save up a down payment

When you’re buying a house with bad credit, saving up a sizable down payment can make it easier to qualify with various lenders. Putting down a chunk of the purchase price means you can pursue a smaller loan. And you can still pay a large down payment even if you’re buying a house with bad credit.

Plus, every dollar you can save up for a down payment is a dollar that won’t be accruing interest on your mortgage. Making a down payment of 20% of the home’s price is a good idea for two reasons:

Loan-to-Value (LTV) ratio

This number compares the amount of your loan to the value of the home.

If you’re buying a $150,000 home and putting down 20% ($30,000), your mortgage loan amount will be $120,000. Compare the loan amount to the home’s value—$120,000/$150,000—and you get an LTV ratio of 80%.

If you only put down 10% ($15,000) the LTV ratio would be 90%. Lenders don’t like to see high LTV ratios, because you’re more likely to default on your loan if you don’t have much equity in the home. Thus, they may charge you higher interest rates if your LTV is above 80%.

PMI (Private Mortgage Insurance)

If your LTV is above 80%, you’ll also likely be required to pay PMI (private mortgage insurance). PMI protects lenders if a borrower defaults on their loan. Since they consider you a higher risk with a smaller down payment, you basically pay PMI in trade for them insuring you.

Now, this doesn’t mean you absolutely have to save a 20% down payment. If you’re paying a lot in rent each month, it could still be cheaper for you to buy a home. Even with higher interest and PMI, as long as you can get approved, of course.

The moral of the story is just that if you can pay 20% or more, it’s a smart thing to do, even when buying a house with bad credit. It might take some time, but don’t be disheartened. Follow these tips for saving a down payment and be patient; you’ll get there!

Once your bank account hits your goal down-payment number, keep saving so you have a buffer. You should still have an emergency fund. Your emergency fund will prepare you for unexpected expenses and life circumstances.

6. Leverage an FHA loan

Federal Housing Administration (FHA) loans are designed to put homeownership within reach for people who may struggle to get a conventional loan. They’re particularly ideal for first-time home buyers, and typically require lower down payments than a private lender may.

You’ll need a credit score of at least 580 to qualify for an FHA loan with a 3.5% minimum down payment. If your credit score is between 500 and 579, you’ll need a 10% down payment to get an FHA loan. So buying a home with bad credit is still possible.

 

Category: Home & Real Estate

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I’m David Duke and with my wife Claire,11 year old daughter Emmy and my son Jackson we love exploring and spend most of our free time traveling. We believe travel can change the world, that it's the best education for kids and for families to spend time together. We hope you can find the joy in travel that we have. Love from Florida and the whole World

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