Is it Possible to Purchase a Home With Bad Credit?
Buying a house for the first time is truly one of the most exciting times in your life. Making home ownership a reality is still the goal of a significant percentage of the population. One of the most popular questions of potential home buyers to lenders is whether or not they will qualify to get a mortgage.
Lots of people want to buy a home but aren’t sure if they will be financially able to. If you are shopping for a home and have bad credit, you may be wondering whether your poor credit will hurt your chances of buying a home. While it is true that having bad credit can result in higher rates or even a larger down payment, buying a home can still be a reality if you have bad credit.
One of the mysteries among home buyers or those looking to refinance is how lenders determine what the interest rates will be. Below, we will reveal how most lenders use various factors, including your credit scores, to determine your interest rate.
Every lender has a rate sheet which is usually not available to the public. This is something their loan officers will view, and if they also use a broker network, then the brokers can see the rate sheet as well.
The rate sheet will show rate adjustments for various conditions such as down payment percentage, whether the home is a second home or an investment if you are cashing out money, and even if you plan to escrow your taxes with the lender. These are just a few examples of things that can create a positive or negative adjustment to the final rate the lender will offer you.
Credit scores are the single most crucial factor when it comes to determining your interest rate. The higher the credit scores, the better the rate. As your credit score worsens, your interest rate also increases.
In most instances, a credit score of 740 will get you the best possible rate from a credit perspective. Conversely, anything under a 580 score will likely result in the highest possible rate.
We also need to share that your down payment percentage also plays a significant part in determining your interest rate and the lower the credit score, the more you will be required to put down.
How Bad Credit Scores Can Reduce Buying Power
Now that you know credit scores can impact your interest rates, it naturally also means that your credit scores can have a significant impact on your buying power. Here is an example of how bad credit scores can impact your buying power:
Michael is shopping for a home in Massachusetts, and Amanda is shopping for a home in Texas. They both make the same amount of money and in theory, could qualify for the same mortgage amount if all other conditions were the same. However, Michael has a credit score of 590, while Amanda has a score of 756.
Michael is offered a rate of 6% on a $300k loan, which results in a payment amount of $1,798.
Amanda is offered a rate of 4.5% due to her excellent credit and can qualify for a loan amount of $355k while having the same payment of $1,798.
This means Michael’s buying power was reduced by $55k in this example simply because of his low credit scores.
How Bankruptcies and Foreclosures Impact Your Credit
If you filed for bankruptcy or had a foreclosure or even a short sale, your credit will drop significantly. However, you can immediately begin rebuilding your credit by establishing a positive payment history. It is not uncommon to find individuals who filed for bankruptcy within the past year but were able to improve their credit scores since that event occurred.
One of the issues you will find after a bankruptcy or foreclosure is most lenders will not allow you to get a mortgage until two years have passed. Even FHA, VA, and USDA guidelines will require you to wait a minimum of two years before applying for a mortgage.
There are subprime lenders who will help you to get a mortgage after bankruptcy even if your bankruptcy was discharged as recently as yesterday. However, you should be prepared to come to the table with a down payment of at least 20%.
Mortgage Options for Those with Bad Credit
At the beginning of the article, we indicated that you can still buy a home with bad credit. Yes, there are mortgage options for you, but virtually none of them can be found at your local, national bank on the corner. The large national lenders prefer to work with individuals with excellent credit and any loan that can be Fannie Mae approved.
There are nationally licensed lenders who have loosened their guidelines to allow those with less than perfect credit to apply for a mortgage. These bad credit mortgage lenders who are also called subprime lenders, accept low credit scores and even recent credit events such as bankruptcies or foreclosures. The rates will be at least 1%-2% higher depending upon your personal scenario.
FHA guidelines also allow for credit scores as low as 500 with a down payment of 10%. However, most lenders prefer not to work with borrowers who have credit scores that low. There are FHA lenders who will accept those low scores and can help you to buy your dream home.
FHA is not the only government program that will permit lower scores. Some lenders are helping veterans with low scores and people living in rural areas with a bad credit USDA loan. Just like with FHA, not all lenders allow for the lower scores even though the guidelines permit them.
How to Improve Your Credit Scores
In this article “How to Financially Prepare Yourself Before Looking at a Home,” it is recommended that you begin working on your credit and start discussing your mortgage options well before visiting homes with your local real estate professional. This advanced discussion can identify areas of improvement with your credit, so you have time to make changes and corrections.
There are so many different activities and techniques to improve your credit score. For this purpose, we will focus on just two.
- The obvious one is to make your payments on time. No late payments (especially mortgage payments) will go a long way to improving your credit scores. Many people cannot afford to make all of their payments each month. However, you should still send something. Sending a partial payment on time is better than being late.
- Your balance to credit limit ratio needs to be less than 30%. This means, if you have a $1,000 credit limit on your credit card, then you need the balance to be less than $333. You can do this by paying down the balance, of course, but there is also another way to accomplish this.
Call the credit card company and ask them to raise your credit limit. They may do this for you if your account is current. This will help with that ratio even without paying the balance down because of the credit agencies it will look like you are not over-leveraged financially.
To recap, if you are planning to buy a home, your first step would be to understand what your credit situation is and make improvements before you begin shopping for a home.
For many home buyers who find themselves in the position to make an offer now while having bad credit, you can see there are still options for you. You no longer have to let your credit issues stop you from buying your next home.
Other Mortgage Articles Worth a Look
- What do you need to apply for a mortgage – take a look at this handy mortgage check list to see exactly what a lender is going to need in order to grant a mortgage approval.
- How to pick a loan term for your mortgage – see tips and advice on how to go about choosing a loan term that makes sense for your financial needs.
Use these additional mortgage resources to make the best financial decisions when you are buying a house.
About the author – the above article on can you buy a house with bad credit was written by Eric Jeanette. Eric started as a Realtor in 1993 and eventually transitioned to lending. His companies Dream Home Financing and FHA Lenders provide mortgage information and education to consumers. They also provide those same consumers with a free lender match service through a network of lenders for conventional, FHA/government, subprime, self-employed and many other niche loan programs.