If you dream of owning your own home, then you’re not alone. According to CNBC.com, most adults in the U.S. see home ownership as an essential part of achieving the American Dream. But what if your credit rating is less than stellar? Although it’s true that a poor credit rating can make the home buying process more difficult, it doesn’t make it impossible. Learn how to buy a house with bad credit in six simple steps.
1. Maximize Your Credit Score
Before you visit a mortgage lender to apply for a home loan, it’s important to maximize your credit score. Joshua Rodriguez, owner and founder of CNAFinance.com, makes the following recommendations:
- Get a free copy of your credit report from sites like AnnualCreditReport.com.
- Check your report for accuracy, and dispute errors with the credit bureau if needed.
- Pay off balances and ask creditors to remove these entries from your credit report.
The following table courtesy of Tracie Fobes at Penny Pinchin’ Mom.com shows typical credit score ranges for various categories from bad to excellent (scores vary slightly depending on the credit reporting service used):
Credit Score Ranges:
760 and up: Excellent
700–759: Very Good
579 and lower: Very Poor
2. Lower Your Debt-to-Income Ratio
In order to qualify for a loan, people buying a home with bad credit need to get their debt-to-income ratio as low as possible. This measurement is the amount of debt that you have in comparison to your income. For a home loan, buyers have to meet a DTI of 43 percent or lower, which means that for every $100 of income you bring in each month, your total debt needs to equal $43 or less. To bring down your debt-to-income ratio, the folks at Bank of America suggest avoiding any new debt and increasing the amounts you pay toward your current debt.
3. Apply for an FHA Loan
An FHA loan makes a great option for people buying a house with bad credit. If you have a credit score of 580 or higher, then you can qualify for an FHA loan by making a down payment of just 3.5 percent. If your credit rating falls between 500 and 579, then you have to make a down payment of 10 percent to qualify for an FHA loan. Due to the lax down payment and credit requirements, this loan is popular for first-time home buyers, but there are a number of other conditions to meet before an FHA loan can be processed, so make sure to learn all you can about the FHA loan process.
4. Make a Larger Down Payment
The best way to buy a house with bad credit is to save for a down payment of 20 percent or more. A large down payment shows your lender that you are committed to your investment, and with 20 percent down, you can avoid paying private mortgage insurance. More benefits of a larger down payment include:
- Instant equity in your home
- Less interest paid on your loan
- The potential for a lower interest rate
- A smaller monthly mortgage payment
Weigh the pros and cons of going with a low down payment option right now versus renting for a longer period of time while you save up a more sizeable sum.
5. Ask About Seller Financing
If an FHA loan doesn’t work out, then it’s possible the seller could finance your mortgage. In this situation, the seller extends credit to you in the amount of the home’s purchase price, less the down payment. Both parties sign a promissory note containing the terms of the loan, and a deed of trust is filed with the county clerk. The buyer then pays back the loan amount plus interest over a specified period of time. Less than 10 percent of sellers are willing to provide seller financing, so this option is a long shot.
6. Get a Co-signer
If all else fails, a co-signer can help you qualify for a mortgage if you have bad credit, but co-signers must also consent to a review of their financial status. Only take this step as a last resort because your co-signer is responsible if you fail to make mortgage payments on time or go into foreclosure. It’s a business relationship that shouldn’t be taken lightly.
Although poor past financial practices have taken a toll on your credit rating, there is light at the end of the tunnel. Chances are you can buy a house with bad credit by following these six steps and seeing where each avenue leads. To furnish your new home without spending a fortune on new furniture at the outset, check out CORT Furniture Rental for stylish pieces delivered to you and picked up when you’re ready to buy your own.