How to Buy a House With Bad Credit

What is a bad credit score?

A bad credit score ranges from 300 to 579, according to the FICO scoring model. For VantageScore, a bad credit score is known as subprime and ranges from 300 to 850. While many loans require certain credit scores, others are more flexible with their homeownership requirements.

Instead of damaged credit, some homebuyers may have a thin credit file or no credit history at all. If you want to buy a house with no or limited credit history, it is still possible, but you may face other requirements, such as a manual review or additional credit documentation.

Talk to your lender to see what additional requirements may apply. After all, they are the best source on how to buy a house with bad credit.

FICO scoring model

The FICO scoring model uses the following credit score ratings.

VantageScore scoring model

There are several VantageScore models, with the 4.0 model ranging from subprime to super prime.

» MORE: How to check your credit score

Pros and cons of buying a house with bad credit

If you’re considering buying a home with bad credit, be sure to consider these pros and cons first.

It is critical that homebuyers carefully assess loan terms when comparing different loan options.

Many homebuyers tend to focus on the interest rate, but it is critical that you also consider these additional costs and fees so you can compare overall loan costs.

• APR
• Monthly payment total (principal and interest)
• Mortgage insurance
• Taxes
• Fees

Low-credit loans may seem appealing at first glance, but once you take a deeper look into these fees, you may find that this home loan may not be worth the expense after all.

6 ways to buy a house with bad credit

Buying a house with bad credit is possible. However, the requirements and journey will be different from someone with good or excellent credit. Not only will you need a lender that accepts borrowers with poor credit, but you also must prove it is safe for lenders to finance your loan.

Here are a few strategies you can use to buy a house with bad credit.

1. Conventional loans with compensating factors

If you have fair or low credit, you may still qualify for a conventional loan. Lenders typically take into account compensating factors that may positively sway their decision.

• Larger down payment
• Low DTI
• Strong cash reserves
• Mortgage insurance

However, even with these additional factors, loan rates, terms and fees may still be less favorable than those of an FHA or other type of loan.

2. Consider a government-backed loan

A government-backed loan is another example of how to buy a house with bad credit.

Private lenders offer these loans, but the government guarantees them. This reduces the lender’s risk, allowing them to relax lending standards in turn.

The most popular government-backed loans include these three types of loans.

• Federal Housing Administration (FHA)
• U.S. Department of Agriculture (USDA)
• U.S. Department of Veterans Affairs (VA).

All of these options require a low minimum credit score or no credit score to qualify for a mortgage.

FHA loans

FHA loans are generally the best option for people with bad credit. Additionally, you must also meet other loan requirements related to your debt-to-income (DTI) ratio and income.

If you have a credit score between 500 and 579, you can qualify for a 10% down payment. However, if you have a credit score of 580 or higher, you can qualify to put down as little as 3.5%.

FHA loans also carry an FHA Mortgage Insurance Premium (MIP). This is a mandatory fee that adds to overall loan costs. It protects lenders against default, with an upfront 1.75% payment at closing and an annual premium of 0.45% to 1.05% that is divided into monthly installments.

VA loans

VA loans are available for military members, veterans and eligible family members. They come with multiple benefits, including no minimum credit score and no down payment. However, keep in mind that there is a VA funding fee that is a required one-time payment that ranges from 0.5% to 3.3% for most VA-backed and VA direct home loans.

If you qualify for a VA loan, contact the VA to get a Certificate of Eligibility (COE).

USDA loans

USDA loans help low- and moderate-income households in eligible rural areas afford homes. USDA loans don’t require a minimum credit score or a down payment, but applicants must demonstrate a willingness and ability to repay debts.

Other application requirements include having a household income that doesn’t exceed 115% of the median household income. You must also agree to make the property your primary residence.

» COMPARE: Best bad credit home loans

3. Use a co-signer

If you know someone with good credit who’s willing to co-sign your loan, this can help you get a home loan. Their income and assets, when combined with yours, may increase your approval chances and give you a better loan.

“Co-signing a loan is a big deal because that person is taking responsibility in the case that you can’t pay,” said Todd Stearn, founder and CEO of The Money Manual, a financial education website. “So if you don’t pay on time, every time, this will negatively impact the co-signer’s credit score.”

Note that co-signers and co-borrowers are two completely different parties. A co-borrower completes a joint application and shares financial responsibility for the entire loan with you. A co-signer, on the other hand, only becomes responsible if you default as the main borrower.

“If you’re able to get a family member or friend to co-sign, know that they’re doing you a huge favor,” said Stearn.

4. Put down a larger down payment

If you’re able to put down a larger down payment, you may be able to qualify for a loan with bad credit.

A bigger down payment costs more upfront, but it reduces the size of your mortgage, reducing the lender’s risk in turn. It will also start you off with more equity in your home.

5. Gather upfront cash

A down payment is not the only kind of funds you will need. You will have to have some cash to close, as not all homebuying costs are rolled into your mortgage.

Many homebuyers tend to focus on their credit score and the minimum down payment, but these are not the only factors a lender considers. It is critical to have upfront cash that can cover immediate homebuying expenses.

Closing costs are one common expense, prepaid taxes another. You also may be required to obtain homeowners insurance to better secure your loan.

For these added costs, lenders will look to see if you have sufficient cash reserves.

» MORE: How much house can I afford?

6. Consider a rent-to-own agreement

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 it.

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

Lender evaluation checklist beyond credit score

Your credit score is not the only factor that lenders consider when approving or denying a home loan. There are lender evaluation factors beyond credit scores that impact their decision, including debt-to-income ratio, cash reserves and more.

Debt-to-income ratio

Your debt-to-income (DTI) ratio shows lenders how much debt you have relative to your income. It helps them assess whether you have too much debt or whether you can reasonably afford to take on more through a home mortgage. 

Try keeping your DTI ratio below 35%, although some lenders may accept DTI ratios as high as 50%.

Cash reserves

Many lenders consider your upfront cash savings, or cash reserves, as another factor in their approval process. They want to see that you have enough savings to handle your ongoing expenses before taking on a mortgage. 

Typically, you should have at least six months’ worth of expected monthly payments saved to get the best mortgage rate.

Employment history

Lenders also look for long-term employment stability before approving a loan. They do not want someone who skips from job to job with unstable income. 

Regular employment provides greater income stability that will help you make your future mortgage payments. 

Rental payment history

Lenders also consider your rental payment history. A history of consistently making timely rental payments shows lenders that you pay what you owe. 

It shows that you are likely ready for the responsibility of homeownership. 

Down payment

The average down payment is 20% of the home purchase price. However, a larger down payment can result in better loan terms and interest rates. 

Additionally, it can help make up for a lower credit score or a high DTI ratio, while helping you avoid private mortgage insurance (PMI) costs. 

Loan type

The type of mortgage you choose can also impact loan requirements. 

For example, conventional mortgages typically prefer scores above 670. Meanwhile, FHA loans allow scores as low as 500 with 10% down.

What to do if you can’t get a home loan with bad credit

If you can’t get approved for a home loan, be sure to take the following measures to fix your credit.

Prepare your documentation

You will need to provide certain documentation with your mortgage application. Be sure to gather the following income documentation that lenders typically request.

• Pay stubs
• W-2s or tax returns
• Bank statements
• ID
• Debt records

By having these documents ready, you can streamline the home mortgage process, improve your chances of approval and avoid unnecessary delays.

Check your credit report for errors

One of the first things a lender will do is pull your credit report before approving your mortgage.

Your credit report is separate from your credit score, providing a more detailed look at your financial history. You can check your credit report for free at AnnualCreditReport.com.

Ensure everything is correct. Credit bureaus occasionally have discrepancies, like listing loans you’ve already paid off or confusing your name with someone else’s.

Focus on improving your credit first

If you’re unable to get a loan with bad credit, you’ll need to take steps to improve your credit.

• Make payments on time. A history of timely payments helps build your score. A poor payment history with late and missed payments damages it.
• Limit use of available credit. Generally, it’s best to keep your credit utilization under 30%.
• Don’t close unused accounts. Another factor that impacts your credit score is how long your oldest account has been open. Some lenders may close credit accounts after extended periods of inactivity, so make sure to keep your oldest credit card account active.
• Avoid new credit. Too many hard inquiries in a short period of time 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.

While it can be frustrating to delay homebuying, taking the time to improve your credit will ultimately lead to better terms and rates. You can work with a credit counselor or work independently to improve your score.

Keep in mind that certain actions, such as lowering revolving utilization, avoiding new hard inquiries and correcting credit report errors, may be reflected on your credit report as soon as the next billing cycle. With only a short delay, it may be worth the wait to improve your score before applying for a mortgage.

Reduce your debt or increase your income

Reducing your debt or increasing your income will improve your DTI ratio. This compares your current debt to your income. It’s another critical metric lenders look at when making a lending decision.

Having a healthy level of income and few debts shows mortgage lenders you’re likely to have enough cash to make your monthly mortgage payments.

How to shop lenders and compare preapproval offers

It is important that you shop around and obtain preapproval offers from the right lenders. While our list of best mortgage lenders is an easy place to start, these are some additional factors to keep in mind during your search:

• APR
• Rate
• Lender fees
• Mortgage insurance
• Credit-score overlays
• Preapproval terms

It is critical to compare terms and credit policies across multiple lenders because interest rates and fees can vary significantly from lender to lender.

Alternative paths when standard mortgages are out of reach

Not everyone qualifies for a conventional home mortgage. However, it is not your only option for a home loan.

Alternative mortgage loans

These alternatives to a traditional home mortgage may be a better fit for you.

• Payment-option ARM. This adjustable-rate mortgage offers several payment options, such as paying only your interest or paying both your principal and interest. However, this type of mortgage can be extremely risky, as any payments that do not include the principal will fail to pay down any of your principal. Thus, you are only delaying the payoff of your loan.
• Interest-only mortgage. With an interest-only mortgage, you only pay interest for the first 10 years. This can be a risky choice, however, as it prolongs your mortgage debt for 10 years.
• Balloon mortgage. A balloon mortgage is another option. This offers a low payment for a fixed period, typically five to seven years. When this introductory term is over, you pay off the rest of your principal in one lump sum. However, this can be tricky for many homeowners who lack the funds to make such a large payment upfront, even if it comes later.
• Cash-out mortgage. If you already have equity in your home, you may be able to use a cash-out mortgage to refinance your existing mortgage. This may result in a lower interest rate or a better term. However, if the housing market crashes, you may become underwater on your loan and owe more than your home is worth.
• Non-QM. A non-qualified mortgage, or non-QM, does not abide by the consumer protection laws set by the Dodd-Frank Act and the Consumer Financial Protection Bureau (CFPB). These loans do not have regulated interest rates or fees, so they may be easier to get than a traditional mortgage. They can be especially convenient when you need a jumbo loan or are self-employed with income that’s difficult to prove. However, non-QMs often cost more in interest and fees.
• Hard money loans. Hard money loans are a type of secured loan. They require an asset to use as collateral for your loan. If you fail to repay your loan, the lender can legally seize your asset. These loans are typically available from private investors and companies.
• Credit unions. Credit unions are known for more flexible lending options than traditional banks. If you are a member of a credit union, it may pay to check with your credit union first for a home loan before exploring bank loans.
• Seller financing. Many sellers offer assistance with closing costs, but sometimes, they will go the extra mile to offer financing themselves. With owner financing, you make regular payments to the seller directly. However, it is imperative that you review the contract carefully and consider enlisting the help of a real estate attorney who can ensure that the terms are in your best interest.
• Manual underwriting. The computer can be unforgiving when evaluating your application, but an actual human may be a little more empathetic. Manual underwriting is performed by a human underwriter rather than an automated algorithm. You may have to provide additional documentation, but you also may have a better chance of receiving a loan.

Down payment assistance programs and first-time homebuyer help

There are also plenty of programs designed to help homebuyers:

• Down payment assistance. Down payment assistance (DPA) programs may be available from state or local housing agencies, government agencies and non-profits, such as State Housing Finance Agencies (HFAs) and HUD’s Community Development Block Grants (CDBGs).
• First-time homebuyer programs. These first-time homebuyer programs find more flexible lending options, whether it is a loan with a lower interest rate or a smaller down payment required.
• Grants. Homebuying grants are free money for your mortgage that you do not have to repay. They are typically available from government agencies, nonprofits and community organizations. With both state and local assistance available, program guidelines can provide support for low-income, minority and first-time homebuyers.
• Community programs. State and local homebuyer programs may offer additional assistance in the form of home loans, grants or even tax credits. These benefits are typically limited to residents, first-time homebuyers and low-income homebuyers.

HUD also offers special programs for homebuyers who meet specific criteria, such as the Section 184 Indian Housing Loan Guarantee Program for Native American and Alaska Native families, or the Section 811 program for individuals with disabilities. Law enforcement, teachers, firefighters and emergency medical technicians can also receive assistance through the Good Neighbor Next Door HUD initiative.

However, beware of predatory loans. Signs include high-pressure tactics, high rates and fees, incomplete or confusing contacts and pre–payment penalties.

Unfortunately, this is all too common among lenders, so it is critical that you use caution before applying or accepting a mortgage.

Practical mortgage readiness process before applying

Before applying for a mortgage, be sure to take these practical steps to make sure you have everything in order.

Review your finances

Before applying for a mortgage, be sure to check the state of your finances. Request a free copy of your credit report, and be sure to immediately dispute discrepancies that can negatively impact your score.

Also, check your credit utilization. Your credit utilization ratio compares the amount of credit you have versus how much you have used. Lenders generally prefer a credit utilization ratio below 30% for the best terms and rates.

Check closing costs

Lenders will also consider the cost of closing costs. These cover expenses like origination fees, home appraisal fees and attorney fees. 

It is critical that you take time to calculate total closing costs, as these costs add to your total debt and can potentially impact your ability to make your monthly mortgage payments.

Save

You should have not only a down payment saved but also have cash reserves set aside. Lenders assess both the size of your down payment, as well as the amount of cash reserves you have saved.

If you experience a financial emergency in the future, such as job loss or a major medical expense, your cash reserves can help ensure you are still able to make your mortgage payment.  

Get preapproved

Once you are ready to begin shopping for a loan, it is time to get preapproved for a mortgage. After you submit your financial details, you will receive an estimate of how much you can borrow. This letter is typically good for 60 to 90 days.

You can then use your preapproval to begin shopping for the best mortgage for your specific needs.

FAQ

Bottom line

Buying a home with bad credit is possible, but it may be more challenging. You may end up with a high interest rate if you don’t have other factors to offset a low score, like a strong DTI ratio or a large down payment. Still, you may be able to qualify for other types of loans, such as a government-backed loan through the FHA, USDA or VA. 

State and local assistance present other options that include homebuyer grants, tax credits, housing assistance and first-time buyer help for eligible areas. Program rules vary, but they may be an option if you meet the income limits. After all, there is always the option to refinance later.

Carefully weigh the decision of whether to buy now vs. wait. In some cases, it may be better to improve your credit first so you can avoid higher interest rates and secure a lower monthly payment. With a higher credit score, you can qualify for better loan terms. All it takes is some hard work, and you’ll be able to get into a home you love.