How to Buy a House with Bad Credit
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When my wife and I bought our first home in Chicago — during the height of the coronavirus pandemic — there were so many factors to consider that we’d never thoroughly thought of until we were working with our realtor and loan officer. While we knew that our credit history would play a role, we didn’t realize that other factors like our or ability to cover closing costs would also play a part in our eligibility for mortgage rates.
While we had worked hard to raise our credit heading into the homebuying process, we hadn’t realized that there were various loan programs to consider outside of a conventional mortgage that we could have qualified for even with bad credit. One new program in Chicago even offered downpayment assistance for low-income first-time homebuyers — with the bonus of paying off your student loans.
I’m not going to lie: discovering programs like this made me wish I’d known about them sooner, even though I don’t regret aggressively paying off debt to have a better debt-to-income ratio and credit score before filling out a mortgage application. Even so, if you’re hoping to buy a house and take advantage of lower interest rates, you do have options with a bad credit score. Learn more about how to buy a house with bad credit below.
In this article
What does your credit score have to do with buying a house?
Your credit score is a critical aspect of your loan application and may even impact what loan type you’re able to qualify for. Generally speaking, borrowers with lower credit scores get higher interest rates on their mortgages. This may also mean that you’re only eligible for a smaller loan amount because a high-interest rate on a high mortgage can make mortgage lenders worried about your ability to repay the loan.
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What is the minimum credit score required for a mortgage?
Especially in the wake of COVID-19, lenders updated their minimum credit score requirements, so you’ll likely need to shop around a bit more to find competitive rates. It’s also worth noting that when a mortgage lender assesses , they look at the score from each of the three credit bureaus (Experian, Equifax, and TransUnion) and usually look at the middle score when calculating your creditworthiness and risk of default.
While credit score requirements can differ from lender to lender, you’ll need at least a credit score of 500 or better even to begin to be eligible for a loan. Keep in mind that in the credit score ranges of 500 to 580, you’ll likely be limited to an FHA loan (Federal Housing Administration loan), which comes with extra hoops to jump through as a borrower. Generally speaking, you’ll have a few more options shopping around with lenders and a score of 620 or more.
How do you find out your credit score?
While there are plenty of free services offering your estimates, if you’re intending on buying a house, you need to know where you truly stand with all of the three major credit bureaus. Heading to is the fastest and most straightforward way to obtain all three of your credit reports at once. Before talking to a mortgage lender, it’s wise to pull your credit reports so that you can have an informed conversation with your lender about how your credit score may impact your mortgage options, interest rate, and monthly payments.
Loan options for borrowers with bad credit scores
Loan options for Fair Credit (580-669)
Depending on other factors, you may be able to qualify for a conventional loan with a score of 620 or more. You may also be eligible for an FHA or VA Loan if you skew towards the higher end of the fair credit score range. Keep in mind that each of these loans has its own requirements outside your credit score.
Fannie Mae HomeReady Mortgage
As long as you have a credit score of at least 620, you can qualify for Fannie Mae’s HomeReady mortgage program, which is specifically designed for low-income borrowers who don’t have a lot of cash on hand for their down payment. Before applying for this loan, you need to make sure to take a homeownership education course (such as Fannie Mae’s HomeView) if you’re a first-time homebuyer. If you like the sound of just a 3% down payment, then the Fanni Mae HomeReady mortgage is worth researching further.
FHA Loan
With a FICO score of at least 580, you will need a 3.5% down payment to qualify for an FHA loan. You’ll also need to have a debt-to-income ratio of 43% or less. The home also needs to be your primary residence. Mortgage Insurance Premiums (MIP) will also be required as your down payment is under 20%.
Related: Best FHA Lenders for Mortgages
USDA loans
If you’re looking to buy property in a rural part of the United States, it may be worth looking into USDA loans. Sponsored by the United States Department of Agriculture, not all mortgage lenders will offer USDA loans; however, those that do offer them generally do so if your credit score is 620 or higher. Generally speaking, 640 or better is best to qualify for a USDA mortgage.
One of the biggest benefits of a USDA loan is taking advantage of a 0% downpayment. One added requirement that you should be aware of for USDA loans is that your annual income can’t exceed 115% of the median yearly income in the rural area you’re moving to.
VA Loan
To take out a VA loan, you need a credit score of at least 580. A VA loan offers borrowers a wealth of benefits, including no downpayment requirements, no need for private mortgage insurance or mortgage insurance premiums, and the ability to take out a mortgage up to the Fannie Mae/Freddie Mac conforming loan limit in most areas.
To qualify for a loan from the Veteran Affairs department, you will need to apply for a Certificate of Eligibility to prove service history and eligibility status. You may also be able to apply for a Certificate of Eligibility if you’re the surviving spouse of a veteran or the spouse of a veteran who is MIA or a POW.
Related:
Use Quicken Loans to Get a Personal Loan
- If you're tight on cash right now, you may want to consider getting a personal loan. A personal loan is a loan that you can use for just about any purpose like: paying off other debt, renovating your home, or family needs like a wedding or adoption.
- TrustPilot Rating 4.6 out of 5
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Loan Options for Poor Credit (300-579)
FHA Loan
With a FICO score of between 500 and 579, you will need a 10% down payment to qualify for an FHA loan. You’ll also need to have a debt-to-income ratio of 43% or less. The home also needs to be your primary residence. Although this type of FHA loan requires a larger down payment than an FHA loan for those with fair credit, Mortgage Insurance Premiums (MIP) will still be necessary since your down payment is less than 20%.
Down payment assistance programs to consider
Depending on where you live — and your family situation — there are a few different assistance options that could be worth pursuing as a homebuyer with bad credit. The two most common forms of assistance are state or city programs and co-signers. Here’s a quick overview of each of these options.
State and city assistance
Depending on where you live, you may be able to qualify for a wide range of homebuyer assistantships. Many states have first-time homebuyer assistantship programs that help you cover the cost of a downpayment. In Chicago, IL, for example, there are assistantship programs through the Illinois Housing Development Association and the Chicago Community Land Trust. Both of these programs offer residents who qualify for downpayment assistance and other perks as first-time homebuyers with qualifying income and credit scores.
Googling your state and phrases like “downpayment assistance” can help you quickly discover programs you may qualify for. These sorts of programs can often help you better manage your monthly payments so that higher interest rates don’t wind up pricing you out of homeownership.
The ins and outs of co-signers
If you have poor credit or a less-than-ideal credit utilization ratio, it may be worth pursuing a co-signer. Usually, a relative like a parent or a grandparent is most willing to help co-sign on a mortgage with you — and there are a few things you need to know about this option before using it as a magic wand to buy a house with bad credit.
For starters, you must have a strong relationship with the co-signer and talk through what co-signing on a loan means for you and the consignor. A consignor is legally responsible for mortgage payments if, for some reason, you default. As such, it’s worth thinking twice before co-signing on a loan, unless you feel like you will truly be able to cover the cost of a loan every month. The last thing you want is to ruin a relationship over rushing into wanting a home — especially because money can quickly erode trust and understanding in a relationship.
Costs/Fees
The main two things to note when comparing costs and fees from one mortgage lender to another are interest rates and the size of your downpayment. On a large purchase, such as a $250,000 mortgage, your interest rate can make a difference to your overall monthly payments and cash flow. For example, with an interest rate of 4.339% and a 30-year fixed mortgage, your monthly payment will be roughly $1,243 before property taxes are included. However, if your poor credit score pushes you to even a 6% interest rate, your monthly payment will increase by almost $250.
Many people with poor credit often don’t have a large downpayment either. While downpayment assistance programs can help in this regard, if you don’t have 20% down towards your home loan, you will wind up paying private mortgage insurance (also known as PMI). Generally, your PMI rate will be between 0.5% and 1% of your loan amount each year. While this isn’t a tremendous amount of money, it doesn’t go towards building equity and can ultimately raise your monthly payment.
Use Quicken Loans to Get a Personal Loan
- If you're tight on cash right now, you may want to consider getting a personal loan. A personal loan is a loan that you can use for just about any purpose like: paying off other debt, renovating your home, or family needs like a wedding or adoption.
- TrustPilot Rating 4.6 out of 5
- Connect with lenders for $0
- 100% online experience.
Pros/Cons
Pros
- Start building equity. If you’ve been renting in the same area for a while, building equity can benefit your overall finances. While there are significant pros and cons to the topic, building equity in your property can often be advantageous if you plan on living somewhere for several years or more.
- More options than you may have realized. If you have bad credit, you may think that there aren’t ways to get a house. However, once you start doing research, you’ll realize there are many ways to move forward if homeownership is a primary goal of yours.
- Helps provide a stable housing cost. Especially following COVID-19, rental rates have spiked in many areas. A steady mortgage payment means that you can easily budget for your monthly expenses without worrying about your landlord raising your rent.
Cons
- PMI is money you don’t get back. Unless you have a high down payment (in which case — why haven’t you paid all of your debt down?), paying for private mortgage insurance means that you are essentially throwing some of your housing money away each month.
- Extra hoops to jump through. FHA loans may require more strenuous housing inspections, while VA loans may require certifying that you’re eligible for assistance from the Department of Veteran’s Affairs. These added checkpoints can make home buying even more tedious in an already paperwork-heavy process.
- Could be biting off more than you can chew. If you have a bad credit score, it’s important to reflect on whether or not you’re responsible enough to own a home yet. Taking out a mortgage could be a bad move for some borrowers, saddling them with more debt when they’re already incapable of handling their current finances.
The bottom line
For many, homeownership is a significant component of the “American Dream,” especially when paying it forward to future generations. Qualifying for a home loan with a low credit score isn’t impossible, but it is worth knowing that you may have to deal with a higher interest rate and fewer loan options.
While there are several different government-backed lending options for getting a mortgage with bad credit, it is worth thinking about carefully before proceeding. If you haven’t managed your debt to date properly, you need to think carefully before taking out a loan in the size of a mortgage.
Even though there are major reasons to proceed with caution, homeownership could help you save money in some areas. For example, my mortgage is about $150 less a month than rent is in our area. If you live in a high cost of living area, starting to build equity — even if your credit score isn’t as ideal as you’d like it to be — could be a vital step in reigning in your finances and turning over a new leaf.
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Writer
Brent Ervin-Eickhoff is a Chicago-based writer, stage director, and filmmaker with a background in digital marketing and content creation. In addition to Joy Wallet, Brent has written for Complex, Volkswagen, HowlRound, Picture this Post, and Third Coast Review, among others. He currently serves as the Associate Director of Marketing for Content Creation at Court Theatre at the University of Chicago. Brent graduated from Ball State University with Academic Honors in Writing.
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