There may be an in to becoming a homeowner if you’re a subprime borrower.
Pursuing homeownership is a long-term goal for many Americans.
According to the National Association of Realtors 2019 Profile of Home Buyers and Sellers, 75% of nonowners view homeownership as a part of their American Dream.
Record-low mortgage rates, due in part by the economic impact of coronavirus, may be enticing for first-time home buyers. But at the same time, buying a home does come with risks. With this in mind, it’s probably best to do so when you feel financially-prepared, even when the incentives are promising.
Home buying may seem unreachable if you don’t have good credit to secure a home loan, but there are some options available. The following four steps will get you started in the home buying process, even if you have a bad credit score.
Step No. 1: Check your credit report
Home loans are secured loans that use your property as collateral. Your credit score is one of the most important factors in determining if you qualify for a home loan. Your credit determines how likely you are to make mortgage payments consistently and on time. It will also determine the loan amount for which you qualify.
The higher your credit score, the lower risk of an investment you’re perceived to be, and the more likely you are to qualify for lower interest rates. You will be perceived as a higher risk if you don’t have a good credit score, and you will most likely need to spend more to qualify for a home loan because of your poor credit history.
“Lenders don’t want to lend to people who can’t pay their financial obligations,” says Russell Graves, executive director and treasurer of Consumer Credit and Budget Counseling and certified housing counselor.
Before applying for a mortgage, check your credit report with the three major credit bureaus (Experian, Equifax, TransUnion) to understand the factors impacting your score and how it will impact your buying power. You can access a free copy of your report at AnnualCreditReport.com
When you review your credit report, check for any errors that are negatively impacting your credit score. Removing these errors can usually give your score a boost.
“Most people are scared to review their credit report, and a lot of times it contains inaccurate information that can be removed,” says Ralph DiBugnara, president of home qualified and senior vice president at Cardinal Financial.
Step No. 2: Create a housing budget
In addition to your credit report, mortgage lenders may also look at your income from the previous two years, bank statements, and other assets and financial obligations. A home is often the single largest investment people make, so ensuring the borrower can afford it is part of the approval process.
Aside from the cost of a mortgage, other ongoing costs for owning a home include property taxes, insurance, and maintenance. Taxes and insurance premiums may be included as part of your monthly payment or they may be handled separately.
As the United States faces a recession because of coronavirus, creating a household budget for when money is tight should be factored into your budget to ensure you can cover any required expenses.
“It’s important that it’s sustainable for you,” Graves says. “You have to be able to pay for your home in good months, but also during months where you might not have your normal income.”
Step No. 3: Consider lower credit score loans
Most conventional loans aren’t in reach for those with bad credit. Conventional loans are mortgages that are not guaranteed or insured by a government agency. They usually have a fixed term and rate. FICO scores for nearly all conventional mortgage loans was 600 or higher, according to the May 2020 Ellie Mae Origination Insight Report.
If your credit score is on the lower side, you’ll most likely qualify for mortgages with higher interest rates or a government-backed loan specifically designed for those with bad credit.
Some private mortgage lenders who offer Federal Housing Administration (FHA) loans will provide financing for those with credit scores below 580, but you’ll be considered a higher risk.
FHA loans are administered under the U.S. Department of Housing and Urban Development (HUD), and are intended to give assistance to first-time homebuyers who don’t have the best credit or can’t afford a large down payment. HUD loans are available through HUD lenders.
“FHA loans are the most lenient for people with lower credit scores,” DiBugnara says. “They allow forgiveness of some bad debt, such as collections and charge-offs, depending on the size of the debt.”
If you live in an eligible suburban or rural area, USDA loans, backed by the U.S. Department of Agriculture, can help make purchasing a home more affordable. USDA loans offer full financing with reduced mortgage insurance premiums, below-market rates, and don’t require any money down.
Most lenders require a FICO credit score of 640 or better for this type of loan, but you may still qualify if your score is below this amount, as different lenders will have their own credit score requirements.
Step No. 4: Work on boosting your credit score
Before applying for a home loan, identify any negative parts on your credit report to improve at least six months in advance, Graves says.
“Working on your credit can be simpler than you think, and it will help you qualify easier,” DiBugnara says.
Increase your chances for a mortgage approval and receive more favorable loan terms by building your credit. Paying off debts, paying bills on time, decreasing your debt-to-income ratio, and improving your credit utilization are four ways to give a low credit score a lift.
Contact a local housing counseling agency for guidance on buying a home, issues with credit, and to learn more on how to improve your credit to qualify for different loans. HUD-approved counseling agencies will often offer advice for your circumstances for free.
Maybe you don’t have a perfect credit score. Maybe you have credit card debt. Maybe you don’t meet the down payment requirements for your dream home. If this is the case, don’t be discouraged. There are steps and resources to help guide you down the path toward homeownership if you’re willing to put in the work.
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The information contained herein is provided for free and is to be used for educational and informational purposes only. We are not a credit repair organization as defined under federal or state law and we do not provide "credit repair" services or advice or assistance regarding "rebuilding" or "improving" your credit. Articles provided in connection with this blog are general in nature, provided for informational purposes only and are not a substitute for individualized professional advice. We make no representation that we will improve or attempt to improve your credit record, history, or rating through the use of the resources provided through the OppLoans blog.