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 it ranges from 300 to 600. If you have a higher credit score than these ranges, then you technically don’t have bad credit. Instead, you may have fair or near prime credit, which can help you qualify for better loan terms and rates.

FICO scoring model

For the FICO scoring model, the credit score ratings are:

Source: myFICO

VantageScore scoring model

There are several VantageScore models. The 3.0 model ranges from subprime to super prime as follows:

Source: VantageScore

» 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 factor in the pros and cons first:

4 ways to 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 good or excellent credit. Not only will you need to find a lender that accepts borrowers with poor credit, but you’ll need to prove you are a safe risk for lenders to finance. Here are a few ways you may be able to buy a house with bad credit:

1. Consider a government-backed loan

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

Some government-backed loans include loans from the Federal Housing Administration (FHA), the U.S. Department of Agriculture (USDA) and U.S. Department of Veterans Affairs (VA). All of these options require a low minimum credit score or no credit credit score to qualify for a home loan.

FHA loans

FHA loans are generally the best option for people with bad credit. If you have a credit score between 500 and 579, you can qualify for a 10% down payment. Though if you have a credit score of 580 or higher, you can qualify to put down as little as 3.5%. Additionally, you must meet other requirements related to your debt-to-income (DTI) ratio and income.

VA loans

VA loans are available for military members, veterans and eligible family members. If you believe you qualify for a VA loan, you should contact the VA to receive a Certificate of Eligibility (COE). VA loans come with multiple benefits, including no minimum credit score and no down payment.

USDA loans

USDA loans are designed to 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 and agreeing to make the property your primary residence.

» COMPARE: Best bad credit home loans

2. Use a co-signer

If you know someone with good credit who’s willing to co-sign your loan, that could help you get a home loan.

“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, a financial education website.

“Co-signing a loan is a big deal because that person is taking responsibility in the case that you can’t pay,” Stearn said. “So if you don’t pay on time, every time, this will negatively impact the co-signer’s credit score.”

3. 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 larger down payment costs more upfront, but it’ll reduce the size of the mortgage that you need, which reduces the lender’s risk. A larger down payment will also start you off with more equity in your home.

» MORE: How much house can I afford?

4. 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 improving your credit, be cautious and thoroughly review the terms of an agreement before committing to this option.

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

If you can’t get approved for a home loan, you should consider the following steps.

Check your credit report for errors

Your credit report is separate from your credit score, and it includes more information about your financial history. You can check your credit report for free at AnnualCreditReport.com. Make sure everything looks correct and that it’s free from any errors. For example, credit bureaus occasionally make mistakes, like failing to wipe off loans you’ve paid off or mixing your name up 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. While it can be frustrating to delay homebuying, this step will ultimately lead to better loan terms and rates. You can work with a credit counselor or improve your score on your own.

• Make payments on time. A history of on-time payments helps build your score, while late and missed payments damage it.
• Don’t use too much of your available credit. Generally, it’s best to keep your credit utilization at less than 30%.
• Don’t close unused accounts. How long ago your oldest account was opened directly impacts your credit score. 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.

Reduce your debt or increase your income

Reducing your debt or increasing your income will improve your DTI ratio, which compares how much debt you currently have to how much money you’re making. 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.

Bottom line

Buying a home with bad credit is possible, but it may be more challenging. 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 a low score, like a strong DTI ratio or a large down payment. Still, you may be able to qualify for a government-backed loan through the FHA, USDA or VA.

If the cons outweigh the pros, it may be best to put off getting a mortgage temporarily and work on improving your credit score first. With some hard work, you’ll be able to get into a home you love.