Buying a home is integral to the “American Dream,” but it is increasingly out of reach for many hard-working adults.
The property market has been highly competitive over the last year because housing supply has shrunk dramatically. Now, many adults have given up on owning a home and expect they’ll rent for the rest of their lives. While most of the older generations will have their own homes through retirement, less than half of the largest group in the workforce – Millennials – think they’ll have that same luxury.
Despite their pessimism, a competitive market doesn’t mean it’s impossible to own a home – even if you have bad credit.
But what is a bad credit score?
Credit scores are usually based on the FICO scoring system, and different credit bureaus may grade scores differently. This is how Experian ranks them:
- Poor: 300-579
- Fair: 580-669
- Good: 670-739
- Very Good: 740-799
- Exceptional: 800-850
About a third of consumers have a poor or fair credit score. If you fall in that category, don’t give up on homeownership. Some loans cater specifically to Americans with low scores.
A traditional mortgage is usually a fixed-rate loan, so the interest rate never changes. Although this is the kind of loan people typically think of, it’s only ideal for people with a credit score above 620.
By contrast, an adjustable-rate mortgage (ARM) typically has a set interest rate for the first three to seven years but then fluctuates based on the market thereafter. ARMs are better for people with a credit score of 600 or higher. That difference between 600 and 620 might not seem like much, but it can help someone who needs it.
When market rates are lower, the interest on your loan will also be lower. The drawback, however, is that if rates are high, you will pay more too. You’re at the mercy of the economy – you could save money on the interest rate or lose some.
If you have a score as low as 500, you could qualify for a Federal Housing Administration (FHA) loan. FHA loans will cover about 97 percent of your home’s value, so you’ll need to make at least a 3 percent down payment. And until you pay off 20 percent of your home’s value, you’ll have to pay for private mortgage insurance. This covers your lender in case you default on the loan.
Since it’s a government-backed program, you’ll have to go to an FHA-approved lender.
Now that you know the various loan options, it’s time to take a look at the steps to getting there.
Step-by-Step Guide for Buying a Home With Low Credit
With so many loans and interest options, the best thing to do is talk to a professional who can review your situation and find the best path for you.
Step One: Get Your Free Credit Report
The last thing you want is your credit score to be misreported. Go to annualcreditreport.com – you can get a copy of your credit report for free every year. Review all of the information provided. Is your social security number accurate? Are your addresses up to date? Which debts and transactions are causing you to lose points?
If anything looks inaccurate, reach out to your lender. It could be something as simple as a paperwork mistake or as serious as identity theft. Work with your lender to get some documents proving the error, and reach out to the credit reporting agency with the evidence. The Federal Trade Commission even offers a sample letter you can use to dispute any errors.
Step Two: Do What You Can To Raise Your Score
Unless you’re in a rush to buy a home immediately, take some time to improve your credit score as much as you can. Five factors determine your score. From most to least critical are your payment history, outstanding debts, length of your credit history (how long you’ve had your cards), types of credit you’ve used, and amount of new credit.
You can sign up for a credit monitoring service to help you keep track of it all. An app called SmartCredit offers a paid service and is one of the more helpful options. You can also use free tools, although they aren’t as in-depth. Credit Karma is one example. It can flag which credit factors are hurting or helping you the most, but it won’t give you detailed tips on how to fix those issues.
Step Three: Talk to a Professional
The best person to go to is a Department of Housing and Urban Development (HUD)-approved housing counselor. The government trains these counselors, specifically the Department of Housing and Urban Development. Their job is to help you find affordable, quality housing. They’ll get to know you and your situation, so they’ll be able to find local options that suit your situation.
Step Four: Enroll in a Homebuyers Workshop
If you can get into a course locally, it should be free. You can also do it online at your own pace. However, there will probably be a charge for this. Once the course is complete, you’ll get a certificate you can use when you apply for financing. The HUD counselor should be able to help you with this.
Step Five: Look For Fha Loans
As mentioned earlier, Federal Housing Administration (FHA) loans are the best option for someone with poor credit. The loan won’t come directly from the FHA but through an approved, private lender. Your local HUD office should be able to find the best option in your area. Make sure you have enough funds to cover the down payment and the mortgage insurance fee.
Step Six: Try To Get Pre-approved
Like any other mortgage, you can get pre-approved for an FHA loan. Pre-approval can help you save time and narrow your search as you look for a home. Like an approved counselor, this will help you understand what you can and can’t afford so you can look within your price range.
Getting pre-approved for a mortgage also makes you a much more attractive buyer to whoever is selling the home. This is an excellent leg-up, especially in a competitive market like we see today. Once approved, don’t spend money on furniture or other big-ticket items. The banks will monitor your activity so be sure to stay on budget.
Keep three main goals in mind as you move forward in your house-hunting journey: save up for a down payment, track your credit, and work with a professional.
Doing this makes it possible to find a mortgage option that works for you despite your low credit score.