How to buy a house with bad credit

Having less-than-ideal credit can make buying a home slightly more difficult, but there are private and government-backed loan options that make it possible to become a homeowner even if you have bad credit. Other options include raising your credit score before you begin looking for mortgages. Having a higher credit score makes it easier to get a loan and helps you receive the best rates.

We look at what mortgage lenders consider a bad credit score, the options available for homebuyers with bad credit and how to raise your credit score.

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. Additionally, different types of mortgages through the same lender may have varying credit score requirements.

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.

A score lower than 620 can make it more difficult to qualify with most lenders. Even if you qualify, the lender might offer you a much higher interest rate than if your score were above 620.

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.

Can you buy a house with bad credit?

Government-backed loans typically have lower credit score requirements, but homebuyers with less-than-ideal credit can still get a private mortgage if they make up for it in some other way. For instance, you may offer to put more toward your down payment, which reduces the size of the mortgage you need — and the lender’s risk.

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

This costs more upfront, but you start with more equity in your home. This can be a better financial move than putting down less upfront and paying more in interest.

Another strategy is to reduce your total debt now and increase your income. This will improve your debt-to-income 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.

Beyond your finances, you could see if you can find a co-signer to improve your approval chances. When someone co-signs a mortgage, they agree to be responsible for the loan if you fail to make your payments.

Lastly, you can apply for a nonconforming 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.

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.

FHA loans

FHA loans let you put down as little as 3.5% if you have a credit score of 580 or higher. However, you may still be able to get a loan with a credit score of at least 500 — but you’ll likely need to make a 10% down payment. FHA loans also require you to pay a mortgage insurance premium.

Additionally, you must meet the following requirements:

• DTI ratio of 43% or less
• Steady employment and income (proved with documentation)
• Home must be your primary residence

VA loans

The U.S. Department of Veterans Affairs guarantees VA loans for service members, veterans and some surviving spouses. VA loans are available to:

• Veterans who meet service length requirements
• Service members on active duty who have served a minimum period
• Certain reservists and National Guard members
• Certain surviving spouses of deceased veterans

If you believe you qualify, you should contact the VA to receive a Certificate of Eligibility. Some lenders may be able to get the certificate on your behalf.

VA loans come with multiple benefits:

• No minimum credit score
• No down payment
• No mortgage insurance
• No maximum DTI ratio (although lenders must provide other compensating factors if DTI exceeds 41%)
• No maximum loan amount
• VA staff to assist if you have trouble with payments

USDA loans

U.S. Department of Agriculture (USDA) loans are designed to help low- and moderate-income households in rural areas afford homes. The Section 502 Single Family Housing Guaranteed Loan Program has no formal credit requirement, but the USDA says that applicants must demonstrate a “willingness and ability to repay debts.”

These loans only come as 30-year fixed-rate loans, and the property must be located in an eligible rural area. The USDA provides a search tool you can use to see if the area you are looking at qualifies. A down payment is not required on a USDA loan.

Other application requirements include:

• Agreeing to use the property as a primary residence
• Having a household income that doesn’t exceed 115% of the median amount
• Having a maximum DTI ratio of 41%

How to raise your credit score to buy a house

Getting a mortgage with bad credit is possible, but raising your credit score helps you access larger mortgage loans with lower rates. You’ll have more overall options if you raise your credit score before you buy a home.

If you have a mortgage already and don’t plan on moving, boosting your credit score can help you save money on interest payments and refinance if rates drop. Here are some tactics for raising your score and positioning yourself for better homebuying opportunities.

1. Check your report and score every year

Once a year, you can order a formal credit report from each of the three bureaus (Equifax, Experian and TransUnion. Once you get these, be sure to look 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.

Many credit card companies, banks and credit unions offer free credit score monitoring.

Disputing errors and getting them resolved may give you an instant score boost. You can also work with a credit repair company that specializes in finding and disputing errors in your credit history.

Be sure to regularly check your credit score as well — many credit cards and banks provide free credit score monitoring.

2. Make your payments on time

Payment history is the most important factor in determining your FICO credit score. A history of on-time payments helps build your score, while late and missed payments can do damage. With that in mind, make sure you budget carefully to ensure you have enough each month to make your payments on time and in full.

Additionally, set yourself reminders so you don’t forget to pay. You can also set up automatic payment as long as you’re certain you’ll have enough cash each month to cover the payments.

3. Only use credit cards for essentials

Credit cards can be great tools for building credit, but only use them for purchases you have to make, like gas and groceries. This helps you pay off your balance each month and avoid getting into credit card debt.

Additionally, this keeps your credit utilization ratio — your total credit balances divided by your total credit limits — low. Your credit utilization ratio is one part of the amounts owed component of your credit score.

The rule of thumb is to keep your credit utilization at less than 30%, meaning your total balances shouldn’t exceed 30% of your available credit. By only swiping your card for the necessary purchases, you’re more likely to keep your utilization below 30%.

4. Don’t close unused accounts

Your credit mix — the diversity of your open credit accounts — plays a part in determining your credit score. Therefore, you shouldn’t close any of your credit card accounts if possible.

However, lenders may close card accounts after extended periods of inactivity. Consider spreading your essential purchases across a few cards to keep them active.

5. Temporarily avoid new credit

Hard inquiries slightly harm your credit score, and, if you have too many recently, it can make the lender less likely to extend you a loan.

It’s generally a good idea to stop applying for any new credit several months before you plan on getting a mortgage. It’ll maximize your score and show lenders you’re working to manage your debts. That makes you appear less risky to them.

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.