If you have bad credit–a score of 650 or lower–or no credit at all–a score below 600–there are programs, like the Federal Housing Administrations (FHA) loans, specifically designed to help people with poor credit purchase homes. If individuals cannot qualify for conventional mortgages, then FHA loans are the remaining options for would-be homebuyers with poor credit.
Having poor credit means that you likely cannot qualify for a traditional mortgage, but that you may be able to qualify for a home loan with the help of a government-backed program. You might qualify for a conventional mortgage with fair credit, but you may have to be stronger in other areas to compensate, and you may be burdened by higher mortgage rates. Not only would you have more mortgage options, you might also qualify for a loan with lower income requirements and down payments.
Once you raise your score, you might be able to refinance to a new home loan with a lower mortgage rate and monthly payments. You can work on improving your credit score and potentially refinance into a home loan at some point in the future. Always making on-time payments toward your loan, paying off other debts that you have, and ultimately paying your house down, will all help improve your credit. If you manage to qualify for a home loan with a lower credit score, you actually may be able to use the mortgage payments to help improve your score going forward.
Those with poor credit should consider setting aside a larger down payment, since this may help you to qualify for a better mortgage rate. A larger down payment gives you more skin in the game, making you appear less risky to lenders. A larger down payment shows a lender you are more invested in buying a house, because you are putting down more money.
A larger down payment lowers the amount that you have to borrow, which increases your chances of getting approved for a mortgage. Making a larger down payment signals to lenders that you are more creditworthy, giving you a better chance of getting approved for your mortgage, and potentially lowers your interest rate. Putting more money down on a mortgage, in effect, means that you are putting more of your collateral down for the loan, and it makes the lender see you as less likely to default and as a low-risk borrower. If you actually do qualify for a mortgage, either a regular loan or a mortgage through a special loan program, then you are probably going to have to pay a higher interest rate on the mortgage.
A subprime loan borrower also might need to make a much higher down payment than someone with better credit. Borrowers with scores under 580 might struggle to qualify for a loan, or at all, to find decent terms on the loan. You may have lower debt or a stronger payment history than those borrowers with worse credit.
You can improve the odds that you will get approved for a loan under favorable terms, even with bad credit, by optimizing the other parts of your borrower profile. For instance, you could technically qualify for an FHA loan with a mid-range credit score of 500, as long as you find a lender that is willing to work with you. For instance, if you have a score at least 580, you could only pay 3.5% down and qualify for an FHA loan. Most FHA loans typically require that you have a score of at least 500-580.
Regardless, lenders are becoming less likely to approve a home mortgage loan to borrowers with a 500-credit score–an FHA loan is probably the only kind that is available in that scenario, and most FHA loans issued to borrowers with 500-credit scores require 10% down payments. While many mortgage lenders will not make loans to those with poor credit, a few lenders will actually make loans to those with lower scores. Unfortunately, with a lower credit score, a mortgage that you are eligible for is more likely to have a higher interest rate, meaning that you end up paying more interest over the life of your loan.
If you take advantage of available home loans, and do enough research to know that you are getting a better rate, you can afford to purchase the house, and potentially build up your credit as you make payments on your mortgage. Even if your credit is not great, you still have options to purchase a house. Contrary to popular belief, it is possible to get a mortgage, even with less-than-stellar credit.
Because applying for a mortgage with poor credit may mean that you only qualify for one loan, which could be hard to repay, it might be wise to hold off on buying a house until your credit score has improved. However, just because you are struggling with credit issues does not mean that you are automatically destined for mortgage rejection. It is safer to take out a mortgage only now if you are sure that you will be able to afford it in the long run, even if you are hoping to refinance or sell the house after several years. If you are willing to wait just a little longer to purchase a home, you may increase your odds of getting approved and probably land on a lower interest rate by building or improving your credit score before applying for a home loan.
Some prospective homebuyers might have to take a year or more to fix their poor credit and build up a solid payment history. Those who have had credit problems in the past can usually build up their scores over time and qualify, even with FHAs newly updated minimum credit score requirements. Some states also offer programs that promote home ownership by giving qualified borrowers a chance to obtain a home loan with poor credit. Because the federal government underwrites these loans, lenders can offer a softer qualification standard–opening doors to homeownership for people who would otherwise be shut out. There is a range of home-mortgage programs designed for first-time homebuyers that permit lower credit scores, including FHA loans that are available for borrowers with scores as low as 500 (though those loans will require 10 percent down payment).
If you determine you can afford up to $300,000 worth of house, but you have still got lower than desired credit scores, you may improve your chances of being approved for a mortgage by choosing a $250,000 house. Putting a large portion down on your purchase price means that you will be able to qualify for a smaller loan.