If your credit isn’t the best, you could be forgiven for assuming that a home loan is just out of your reach. Most people who get conventional loans have a score of at least 700, so if your score is in the 600s or below, a conventional loan may not be for you.
However, nearly seven percent of conventional loan borrowers have a credit score between 650 and 699, while a little more than one percent have scored even lower than that. So, while it’s unlikely that you’ll get a conventional loan with a low credit score, it’s not impossible.
Of course, you can also apply for non-conventional loans, like those offered by the Federal Housing Administration (FHA), the Veterans Administration (VA), or the U.S. Department of Agriculture (USDA). You can get an FHA loan with a credit score of 500 and 10 percent down, while VA loans and USDA loans have no lower credit limit. Here’s how to finance your home purchase when you have a lower credit score.
Know the Cost of Buying a Home with Bad Credit
The main reason why people say you should have great credit before you try to buy a home is that your credit score determines the interest rate you’ll receive on your loan. The better your credit score, the lower your interest rate, and the lower your interest rate, the less you’ll pay for the loan.
If you have lower credit, you’ll have to pay a higher interest rate on your loan. For example, someone with an excellent credit score of 760 to 850 might get an interest rate as low as 2.805 percent, which means they’ll pay $135,525 in interest over the life of a 30-year fixed loan of $282,240 (which is about what you’d pay for the average home in the U.S., after making a 20 percent down payment). Someone taking out that same loan with a credit score in the low 600s will pay $226,205 in interest over the life of the loan.
That’s a lot more money – so much more that you might be tempted to hold off on buying a home until you can get your credit score up. But home prices are going up steadily around the country right now, and interest rates could go up too. You can’t look into the future and see how much it will cost you to get a mortgage six months or one year into the future. But if you’re looking to get a mortgage in a hot market like Charlottesville, VA, it’s probably best not to wait if you can help it. You can always save money on interest by paying extra towards your principal in the early years of the loan.
Look for Bad Credit Home Loan Options
Bad credit home loans are available from the USDA and the VA with no minimum credit score requirement. If you’re a first-time homebuyer, many states offer loan programs with low-interest mortgage options and even down payment grants to help buyers get into their first homes. The HomeReady loan from Fannie Mae and the Home Possible loan from Freddie Mac also offer avenues to homeownership for low-credit borrowers.
Don’t Make Any Big Purchases Until After You Close
Once you’ve decided to start applying for mortgages, you should avoid making any large purchases on credit, getting any loans, opening any credit cards, or basically making any financial changes at all until after you’ve closed on your new home. Charging large purchases or taking out new loans affects your debt-to-income ratio, which needs to stay stable throughout the underwriting process – and if you buy too much on credit while you’re in underwriting for a home loan, you could torpedo the loan. Opening new credit cards could lower your credit score, which you want to avoid during underwriting.
The only financial changes you should be making while you’re in the process of shopping for and securing a mortgage are those changes that could improve your credit score, like paying off outstanding debts or disputing inaccurate data on your credit report. These kinds of changes might not appear on your credit report for up to a month after they occur, but if you’ve done a lot of work on improving your credit score in the last weeks before you apply for a mortgage, ask your lender to do a rapid rescore. A rapid rescore will expedite the appearance of positive changes on your credit score, but it will also expedite negative changes, so use it wisely.
Getting a mortgage with bad credit isn’t as impossible as you might think. There are actually a lot of different mortgage options for bad credit borrowers, so if your credit isn’t great, don’t despair – home ownership is not out of reach for you.
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