How to get a loan with bad credit
While owning a home might seem like an excellent way to build personal wealth, first-time buyers with bad credit, or less than perfect credit might run into trouble when trying to secure a mortgage.
Financing can be tough to come by when your credit score is less than ideal, but there are loan options available. Certain lenders and government programs can be more lenient towards borrowers with credit trouble in their past. Let’s take a look at your credit’s impact on lending and how to get a loan with bad credit.
Credit’s impact on lending
When you apply for a mortgage, one of the first steps your lender will take is a thorough examination of your credit history.
By closely examining your previous financial patterns, lenders and credit agencies are able to project the likelihood of your ability to repay the loan by producing a credit score. This number allows creditors to get a snapshot of your experience repaying loans and managing existing debt. Your credit score also reflects any delinquent payment patterns or missed payments in the past.
A higher credit score means lenders will be more confident in approving a mortgage application since the borrower can demonstrate a solid record of managing debt.
A low credit score, on the other hand, shows that the borrower has not had a perfect financial past. A score on the lower end of the spectrum can indicate a history of mismanaged debts or haphazard spending, making you seem more likely to repeat those mistakes in the future.
Lenders who do approve loans for buyers with bad credit or less than perfect credit will likely attach a higher interest rate. Interest allows lenders to turn a profit on the financing they provide and is usually higher if the borrower presents a greater risk. By scaling up the interest rate, your lender will be able to make back their money on the loan and will be less reliant on the borrower’s ability to pay back the principal.
What is considered bad credit?
Before learning how to buy a house with bad credit or less than perfect credit, let’s make sure your score actually falls within the lower range.
Here’s a look at how lenders typically view the range of credit scores:
<580 = Poor
If your credit score falls below 580, you will be considered a heavy risk to lenders and won’t be likely to secure a mortgage.
580-669 = Fair
A credit score in this range, while slightly better than above, will still have a harder time getting approved for a mortgage. While the borrowing options might be narrow, some lenders will be able to issue a loan with a few added provisions.
>670 = Good
For most lenders, a score of 670 or above is considered “good.” This score alone does not guarantee a successful application, but lenders will tend to be more open to financing a loan for a borrower in this range.
Buying a house with bad credit
If you’re looking to buy a home with bad credit or less than perfect credit, applying for a typical mortgage might not be your best option. Thanks to a few government-backed programs, homeownership could be an attainable goal for some first-time homebuyers with bad credit.
Federal Housing Administration loans, or FHA loans, offer home loan options for buyers with a modest income whose credit score might be below average. These loans are acquired by applying through an FHA-approved lender, who will determine your eligibility.
While this financing is not provided by the FHA itself, the FHA does insure the loan and backs up the lender’s financing if the mortgage goes into foreclosure.
If you decide to apply for a home loan with bad credit, government-backed FHA loans might provide the option you’re looking for.
Designed as a mortgage option for low to middle-income buyers, USDA loans are only eligible for qualified areas, usually in a rural or suburban setting. Much like FHA loans, USDA loans are supplied by individual lenders but are guaranteed by the U.S. government.
In addition to lower credit thresholds, USDA loans come with the benefit of a zero down payment and a streamlined process for applicants with a 640 credit score or higher.
VA loans provide mortgage options for active service members, military veterans and their families. Provided by the United States Department of Veterans Affairs, these mortgages offer advantages that lower the credit threshold for prospective buyers.
Most VA loans come with the added benefits of zero down payments, lower interest rates and no monthly mortgage insurance. The VA sets these mortgage conditions and provides a guarantee on the loan. Like FHA loans, financing is still provided by the lender.
Since the VA does not set a credit score minimum for eligibility, buying a home with bad credit or less than perfect credit is much more feasible. Lenders will set their own minimums for VA loan approval, but these conditions are usually more lenient than in a conventional mortgage.
While lower credit will increase the interest rate on a loan, it won’t automatically disqualify an applicant from getting their VA loan approved. Since each creditor has their own limits and approval standards, you should ask your lender about their specific minimum credit requirements.
Managing your credit improvement
It might not be the easiest route to take, but the best strategy for buying a home with bad credit is improving your credit score overall. Let’s take a look at some tactics homebuyers use to improve their credit before taking on a mortgage.
Prioritizing delinquencies and missed payments
If you’re aiming for a mortgage loan with bad credit or less than perfect credit, you’ll first want to clear up any outstanding debts.
Taking the step to settle any delinquent accounts that appear on your credit score will go a long way towards improving your rating over time. Catching up on missed payments wont remove late payments or delinquent payments from your credit report, but will vastly improve your payment history as time goes on.
Accounts with multiple missed payments or debts that were moved to collection agencies may hurt your credit score and could make it difficult to secure a mortgage down the line.
Steady debt payments
Making steady debt payments over time is the most common way of improving one’s credit score. As time goes on, making these regular payments demonstrates an ability to recover from debt and your credit score will likely rise as a result.
Many borrowers have used this strategy by adding utility payments or phone bills to your report. Showing an ability to manage these payments will be reflected in your credit score, giving lenders more of a reason to approve financing.
Avoid hard credit Inquiries
While some credit checks won’t bring down your score, more thorough examinations, or “hard inquiries,” can adversely impact your credit.
Opening a new credit card, applying for an auto loan, or applying for a mortgage will result in banks taking a deep dive into your past. This inquiry can remain on your report for up to two years, and might indicate to other lenders that you should be considered a risk. Repeated hard inquiries can adversely impact your credit score and you’ll be a less-likely candidate for mortgage approval.
While it might be more difficult to buy a home with bad credit or less than perfect credit, securing a mortgage isn’t impossible. Government-backed programs offer special advantages to buyers with a troubled credit history, but you should always consult your lender to understand their specific loan approval terms.
If you want to learn more about your credit and how it affects lending, learn some more about what’s included on your credit report.
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