How to buy a house with bad credit

What is a bad credit score?

Mortgage lenders can differ in what they consider a “bad” credit score, and some may have more rigorous lending standards than others. A bad credit score typically falls below 580, according to FICO.

That said, conventional, conforming loans — those not part of a government lending program but that meet requirements for backing by Fannie Mae and Freddie Mac — generally have a minimum credit score requirement of 620, according to Fannie Mae.

Government-backed loans, such as Federal Housing Administration (FHA) loans, usually have more flexible credit score requirements. However, they may have other restrictions, such as borrowing limits.

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Can you buy a house with bad credit?

Buying a house with bad credit is possible, but your requirements and journey will look different than someone who has excellent credit. Not only will you need to find a lender that accepts borrowers with poor credit, but you will need to prove you are a safe risk for lenders to finance. Here are a few ways you can better qualify for a home loan:

While it’s possible to qualify for a conventional mortgage with a low credit score, government-backed mortgages may be a better option.

• Larger down payment: You may offer to put more toward your down payment, which reduces the size of the mortgage you need — and the lender’s risk. This costs more upfront, but you start with more equity in your home.
• Reduce your debt; increase your income: This will improve your debt-to-income (DTI) ratio, another critical metric lenders look at when making a lending decision. Having a healthy level of income and few debts shows lenders you’re likely to have enough cash to make your monthly mortgage payments.
• Use a co-signer: “If you're able to get a family member or friend to co-sign, know that they're doing you a huge favor,” said Todd Stearn, founder and CEO of The Money Manual. “Co-signing a loan is a big deal because that person is taking responsibility in the case that you can't pay. So if you don't pay on time, every time, this will negatively impact the co-signer's credit score.”
• Use a nonconforming, government-backed loan: These loans don’t meet Fannie Mae or Freddie Mac’s purchase standards. They may not have high credit score requirements, and some may even let you borrow after bankruptcy.

» MORE: How much house can I afford?

Pros and cons of buying a house with bad credit

Even though there are several options for individuals with poor credit to purchase a home, the pros and cons should be considered before moving forward.

Bad credit home loan options

A government-backed loan can be a great option if you have a low credit score. Private lenders make these loans, but the government guarantees them. That reduces the lender’s risk, allowing them to relax lending standards.

Here are some government-backed loan options if you have poor credit.

Bad credit home loan alternatives

If you can’t find a lender that will finance your homebuying dreams, there are two alternative paths you can take that can help.

Improving your credit

It can be frustrating to delay homebuying to work on your credit, but this step will ultimately lead to better loan terms. You can work with a credit counselor or do this on your own:

• Check your credit report for errors. Credit bureaus occasionally make mistakes, like failing to wipe off loans you’ve paid off or mixing your name up with someone else’s.
• Make payments on time. A history of on-time payments helps build your score, while late and missed payments damage it.
• Only use credit cards for essentials. The rule of thumb is to keep your credit utilization at less than 30%. Only swipe your card for necessary purchases.
• Don’t close unused accounts. Your credit mix (the diversity of your open credit accounts) plays a part in determining your credit score. Some lenders may close accounts after extended periods of inactivity, so consider spreading your essential purchases across a few cards to keep them active.
• Avoid new credit. Too many hard inquiries in a short period can make a lender less likely to extend you a loan. Avoid applying for new credit several months before you plan on getting a mortgage.

Rent-to-own agreements

A rent-to-own agreement can be a viable option for those with bad credit. This arrangement allows you to rent a property with the option to buy it at a later date. A portion of your monthly rent goes toward building equity in the home, which can be used as a down payment when you're ready to purchase.

While this offers more flexibility and time to work on improving your credit, be cautious and thoroughly review the terms of the agreement before committing.

Bottom line

Buying a home with bad credit is possible, whether you get a conventional loan or a government-backed loan through the FHA, USDA or VA. You may have to spend more time shopping for lenders, and you could end up with a high interest rate if you don’t have other factors to offset the low score, like a strong DTI ratio or a large down payment.

In this case, you might want to put off a mortgage temporarily and work on your credit score more. Address any short-term credit issues first, then establish a long-term plan of timely debt payments. With some hard work, you’ll be able to improve your credit and get into a home you love.