Buying a house with bad credit can be difficult, but it's possible with the help of the Federal Housing Administration and some proactive measures to improve creditworthiness. Prospective buyers with credit problems should focus on paying off bad debts and saving money for a down payment.
Required Credit Scores
To qualify for a conventional mortgage through a private lender, you typically need a FICO credit score of at least 650. That number is flexible and depends on a number of variables, but a score of 620 usually functions as a hard floor for borrowers. Fannie Mae, the federally backed corporation that underwrites mortgage-backed securities, won't accept loans to borrowers with scores below that amount, making it very difficult for those borrowers to qualify.
However, prospective borrowers with scores lower than 620 may still qualify for loans under special circumstances or through the Federal Housing Authority. The FHA backs loans for borrowers with a minimum credit score of 580. Buyers with credit scores over that level can qualify for home loans with down payments as low as 3.5 percent. Buyers with scores under 580 can still qualify for mortgages in some circumstances, but they must supply down payments of at least 10 percent.
Your credit score isn't the only factor determining your eligibility for a home loan. Several other variables can make it possible to qualify for a loan with poor credit -- or make it impossible to borrow even with good credit:
- Debt-to-Income Ratio: Often abbreviated as DTI, the lower this ratio is the better your chances of qualifying for a mortgage.
- Employment History: Lenders view people who change jobs frequently as high risk. The longer you've been with your current employer, the better your chances.
- Account Standing: If you have delinquent accounts or accounts in collection, your odds of qualifying for a loan are very slim even if your credit score is OK. A delinquent student loan account, for example, automatically disqualifies you for FHA loans.
- Down Payment: The bigger the down payment you can make, the better your chances of securing a loan.
Improving Your Odds
If you have poor credit and you want to buy a home, there are a few steps you can take to improve your odds of qualifying for a mortgage.
First, get up to speed with all outstanding accounts. Obtain a free copy of your credit report and contact anyone to whom you owe money to settle the account. Paying an account in collection won't remove the black mark from your credit report, but the report will reflect that the debt is settled.
Second, reduce your DTI by paying off any outstanding debts as quickly as possible. If you have $10,000 in credit card debt and you make $50,000 per year, your current ratio is 0.2. If you pay half that debt, you can reduce your ratio to 0.1.
Third, save money for a larger down payment. The minimum down payment under FHA rules is 3.5 percent, but if your credit is bad, you want to save much more than that. Aim to pull together enough cash for a 20 percent down payment.