The idea of purchasing a home could be overwhelming. The process of buying a home with bad credit may make it seem impossible to obtain a loan, but did you know there's a bad credit home loan? Your credit score might not be as significant of a hindrance as you think. In this article, we'll discuss buying a house with poor credit, understanding your credit score, qualifying for a mortgage, and increasing your score rapidly.

Can you buy a house with bad credit?

Purchasing a house is feasible for those with bad credit, but it's much more costly and difficult than it is for those with excellent credit.

Since 2018 , lenders have been offering more loans to those with below-average credit scores. But the lower credit score may influence your mortgage rate, associated fees, or even how much of a down payment you're required to pay.

Before starting the home-buying process, it is important to consider why you would like to become a homeowner. Homeownership can lead to huge and unexpected expenses that can be difficult to pay for if your financial position is unstable. Continuing with rent for a long time or until your credit improves might be the best financial option.

What is considered bad credit?

Bad credit  is when your credit score or payment history does not meet the lender's minimum standards.

Some mortgage companies require minimum credit scores of 500 from 300 to 850. Some lenders put their threshold for 580, 620, or more. Minimum credit scores differ between lenders since they don't necessarily look at credit scores. What they're concerned about is whether or not you'll pay back every month.

Credit scores are one of the many factors that determine the creditworthiness of a mortgage lender. They also consider your employment stability, annual income, the property you're purchasing, and many more.

There's no such thing as bad credit for mortgage lenders. There's only qualifying credit, which is the minimum score needed for the mortgage application.

Cash is your most reliable friend in the event of bad credit, and the more you can use towards an initial down payment, the better. The reason lies in the fact that your credit rating could be unable to qualify you for an amount mortgage. If you can pay the rest by cash, you could still afford the house you would like to purchase.

Each lender will have different criteria. Although you may be able to obtain a loan for bad credit, you will need to make a larger monthly mortgage installment due to the much greater interest rates.

What's the first step in buying a home with bad credit?

The first step in purchasing a home with bad credit is to apply for official mortgage approval. The pre-approval will show your credit score, highlight the mortgage options available, and provide a route to better scores. Get this done immediately if you're not planning to purchase a house next month.

Options on How to buy a house with a bad credit score

It is possible to still purchase homes and enjoy excellent rates even with poor credit. If you're a first-time buyer, you can even get government subsidies . Find out what you can about the credit score needed to purchase a house.

There are five mortgage options for people with bad credit. The lender will choose the best one that is suitable for your situation.

1. Conventional Loans (620 minimum credit score)

Conventional loans are the common term for mortgages backed by the largest mortgage agency of the government known as that's the Federal Housing Finance Agency (FHFA).

The FHFA is the guarantor of the majority of U.S. mortgages, so your mortgage is likely to be insured by the FHFA as well. Presently, conventional loans are available to homebuyers who have an average credit score of 620 and pay an initial down payment of 3%.

2. USDA Loans (620 minimum credit score)

A USDA loan is a no-down-payment mortgage for those who live in rural areas of the country and lower-density suburbs. The U.S. Department of Agriculture is the one that subsidizes the program. The program requires home buyers to have an average credit score of 620 by the date of the purchase.

3. FHA Loans (500 minimum credit score)

FHA loans started in 1934 and are the first "bad credit" mortgage loan. FHA loans require a minimum of a 500 credit score. Applicants who have a score of 580 or higher are eligible for a 3.5% downpayment. The FHA also has provisions for those with no credit score at all.

4. VA Loans (580 minimum credit score)

VA loans are mortgages with no down payment for active duty members of the military and veterans. Administered by the Department of Veterans Affairs, the program requires buyers to have an average rating of 580 credit scores at the date of the purchase.

5. Homebuyer Assistance Program (580 minimum credit score)

Homebuyer assistance programs do not usually require minimum credit scores. Instead, they follow the requirements of their accompanying mortgage. For instance, if you're a homeowner using conventional mortgages with a 620 credit score for the homebuyer. The assistance program will also use the minimum 620 credit score for a down payment.

How to improve your credit score

Making a few small changes to improve your credit score before home buying can improve your home buying experience significantly. In the current real estate market, homeowners are more likely to reject offers with a low down payment which will force them to undergo the FHA's strict appraisal process. A better credit score could help you get conventional loans and make more attractive offers on houses more likely to be accepted.

Below are some effective ways to improve your credit score:

1. Check your Credit report to determine why your credit score isn't high and check for mistakes. You can do this for free once a year with Equifax, Experian, and TransUnion at AnnualCreditReport.com.
2. Make sure you pay down all revolving credit lines to increase the credit utilization percentage. It usually leads to an immediate increase in your score.
3. Remove errors from your credit report, particularly late payments.  
4. Consult with a credit repair service to determine whether your credit score can be improved enough for reduced mortgage rates.

Why you should improve your credit score before purchasing a house

Just boosting the quality of your credit score by a few points before purchasing a house can help you save thousands. If you can improve your score enough to allow you to qualify for a conventional mortgage rather than the FHA loan, you'll lower the initial mortgage insurance premium by 1.75% of the loan amount. Additionally, conventional loans typically have lower closing costs and interest rates than FHA loans.

Both FHA loans and conventional loans require monthly mortgage insurance when you can put down less than 20% of the loan amount. An FHA loan will include monthly mortgage insurance for the duration of the loan. You will only be able to get rid of it through refinancing and paying the closing costs for the new mortgage. For conventional mortgages, personal mortgage insurance drops off once the loan balance is equal to 80% of your property value.

Options for buyers who can't obtain a bad credit mortgage

If you have bad credit, the best home loan option is based on how low your credit score is. If your credit score is lower than 600, you may want to think about an FHA mortgage or a VA loan.

The most effective alternative is to begin fixing your credit score before submitting a mortgage application. Although this may not be the only thing that borrowers would like to hear or read about, it's the best option that will save you thousands in interest payments. Not only do you have more options for mortgages, but you could also obtain the loan you want with lower income requirements and down payment.

If you've got a credit score of less than 500, it is unlikely that you will be in a position to make any changes other than to wait until you improve the score. In addition, if you're trying to purchase a home with bankruptcies on your credit report, you'll need to wait for at least two years before lenders begin to consider you for the possibility of a new mortgage.

It is possible to take the necessary steps to improve your score by understanding the following:

1. Payment history. Your payment history is 35% of your credit score. This is why people keep saying "pay your bills promptly" concerning your credit score.

2. Credit utilization . How much credit you're currently using is known as credit utilization. It is 30% of your overall score. The greater the amount of credit you're using, the higher your credit utilization and the lower your score could be. It's best to keep your total credit utilization under 30%.
3. Age of credit history. Your credit history is essentially the age of your oldest credit account, the newest credit accounts, and the average age of the accounts that appear on your credit reports. The duration of the credit report is 15%t in your credit score.

4. Credit mix/types of credit.  When you check your report, you'll find that different kinds of credit appear on your report. These could be revolving credit (like credit cards) and installment loans (like car personal loans or loans). A mixture of credit is a great factor for your credit score and is accountable for its 10%.

5. Amount of new credit received. Having an account less than six months old is typically considered as having new credit. Opening an account affects your score. It will result in a hard inquiry and decrease the average age of your accounts. Be cautious when applying for credit since it will affect 10% of your score.

The Bottom Line

A bad credit score isn't a reason to not make the most out of homeownership. It's more likely that you'll need to conduct additional research when looking for financing. There is a way to buy a home with bad credit, however, it might not be the most appropriate option.

FHA loans are a fantastic option for borrowers, however, modifications to the program following the subprime mortgage crisis can make them a costly loan option. Borrowers should go over the numbers to determine how much improving their credit score and having more cash to deposit could help them before jumping into the home buying process.