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How to Buy a House With Bad Credit
By Aly J. Yale MONEY RESEARCH COLLECTIVE
A low credit score shouldn’t stop you from buying a house. Though it may make the process more challenging (and possibly more expensive), there are ways to make up for that low score and become a homeowner despite it.
Is your credit score on the lower side? Here’s how to buy a house with bad credit.
Table of contents
- Consider other types of home loans
- Work on improving your credit
- Increase your chances of approval
- Frequently asked questions
- Bottom line to buying a house with bad credit
Consider other types of home loans
Credit score minimums vary by loan type. Conventional mortgage loans (those eligible for purchase by Fannie Mae and Freddie Mac) typically require the highest credit scores, so those probably aren’t possible if your score is on the low end. Fortunately, there are other options.
FHA Loans
An FHA loan is likely your best bet for buying a house with bad credit. FHA loans are mortgages guaranteed by the Federal Housing Administration and are great options for first-time homebuyers, as they have low down payment and credit score requirements. FHA loans technically allow for credit scores as low as 500 (if you have a 10% down payment) and 580 (with a 3.5% down payment).
Keep in mind: These are just the minimum thresholds set by FHA. Individual lenders may require higher scores, so be sure to shop around. You may qualify with one lender and not another.
VA Loans
VA loans are mortgages for veterans, military service members and their spouses. They’re backed by the Department of Veterans Affairs and have no minimum credit score — at least one set by the VA. The VA encourages lenders to look at the full financial picture of borrowers instead.
Despite this, most lenders require applicants to meet a minimum credit score to reduce their risk. It varies from company to company, but you can generally expect to need at least a 620 for a VA loan. You (or your spouse) will also have to meet the VA’s military service requirements.
If you meet these eligibility requirements, there are big financial perks to using a VA loan: They require no down payment, and closing costs are limited. Together, these features can save you significantly upfront, particularly compared to other loan options.
USDA Loans
USDA loans are another smart choice if you have a low credit score. These are backed by the U.S. Department of Agriculture and have no minimum credit score requirement, at least from the USDA. Like VA loans, though, individual lenders often set minimums to reduce their risk. You can typically expect to need at least a 640 with most companies.
There is no down payment required on USDA loans, but you will need to buy a home in a qualifying “rural” area. Your household income also needs to fall under 115% of the median for your area.
Shop around
No matter what loan program you settle on, it’s critical that you compare quotes from at least three to five mortgage lenders. Every lender has unique overhead costs and risk tolerance, so their fees, mortgage rates and loan options will vary too. Shopping around ensures you get the best interest rate and terms possible for your scenario. (Freddie Mac even estimates it saves borrowers up to $3,000).
Work on improving your credit score
If your credit score doesn’t qualify you for one of the above loan types, you’ll probably need to increase your score before buying a home.
Here are a few ways to do that:
- Reduce your debts and keep your credit utilization rate – that is, the proportion of your credit limit that you actually use – to 30% or less
- Ask for a higher credit limit on your cards (but don’t use it)
- Become an authorized user on the credit card of another family member — ideally, one who has good payment habits
- Set your bills on autopay and stay on top of payment due dates
- Pull your credit report and dispute any errors you find (here’s how to remove items from your credit report)
- Ask your landlord to report your rent payments to credit bureaus
- Get a secured credit card if you have little to no credit history
Increasing your score could qualify you for a lower interest rate, which means a lower monthly payment and more cash saved in the long haul. See our how to repair bad credit guide for more on improving your score or use our list of the best credit repair companies to get professional help.
It may take time to increase your score, so be patient. If you keep making on-time payments and avoid racking up additional debt, you should see improvement within a few months.
Increase your chances of approval
Your credit plays a big role in your ability to get a mortgage, but it’s not the only factor that mortgage lenders look at. In general, a lender is looking to minimize its risk as much as possible. While a high credit score certainly lowers your risk as a borrower, the following steps can also help your case.
Save up for a larger down payment
A bigger down payment means a smaller loan. The lender has less cash on the line if you fail to make payments, and it can help offset some of the risk your poor credit score poses.
To increase your down payment, you can:
- Ask for help from family members or friends
- Set up a crowdfunding campaign
- Ask for cash gifts (for birthdays, graduation presents, weddings, etc.)
- Use a roundoff app (like Chime, Digit, or Acorns) to help you save more
- Cut back on subscription services and other nonessentials, at least temporarily
- Increase your hours or ask for a raise
- Take on a side gig for extra money
For first-time homebuyers, there are also grants and down payment assistance programs that might be able to help. State and local housing agencies typically offer these.
Get a co-signer
A co-signer is someone who agrees to share in the legal responsibility of the loan. If you stop making your payments, the co-signer would be obligated to step in and make them for you.
Co-signature is another strategy for reducing the lender’s risk and improving your loan chances, but make sure you choose your co-signer carefully. They should be someone with a good FICO score and a spotless credit report (i.e., consistent on-time payment history). They also need to be fully aware of the responsibilities of co-signing the loan and be willing to take those on.
A quick note here: A co-signer is different from a co-borrower. A co-borrower is someone who is actually taking out the loan with you (your spouse, roommate, etc.) They are obligated to make loan payments from the start. A co-signer only pays if the primary borrower fails to do so.
Work to pay off other debts
Reducing your debts has a two-fold benefit. For one, it increases your credit score. On top of this, it also lowers your debt-to-income ratio — another big factor in a lender’s risk analysis.
Typically, lenders want to see a DTI of 43% or lower — meaning your minimum debt payments (plus your expected mortgage payment) take up no more than 43% of your monthly income. If you can get yours lower than this, it will only help your case. (The fewer debts you have, the easier making your payments will be — a huge plus for lenders.)
The Bottom Line to Buying a House with Bad Credit
Buying a house with bad credit has its challenges, but it’s not impossible by any means. If you have a low credit rating and hope to become a homeowner, reducing your debts, increasing your down payment and choosing the right loan option can all help your chances.
You might also consider speaking to a financial advisor or mortgage professional. They can make personalized recommendations based on your credit score, budget and homebuying goals.
