Buying a home with bad credit

Key takeaways

• A credit score, typically ranging from 300 to 850, is a key factor in mortgage approval and interest rates, with many lenders preferring scores of 620 or higher but some loans available for scores as low as 500.
• Buyers with bad credit may still qualify for government-backed loans, including FHA loans with 3.5% down at a 580 score or 10% down for scores between 500 and 579, as well as VA or USDA loans with no down payment in some cases.
• Improving approval chances involves steps like paying bills on time (which accounts for 35% of a FICO score), reducing credit card balances below 30% utilization, avoiding new credit inquiries, saving for a larger down payment and shopping among multiple lenders.

Your credit score is a major consideration when buying a house. It shows mortgage lenders how likely you are to pay back a loan and plays a role in determining your interest rate and the terms you’re offered.

Buying a house with bad credit is a challenge, but it doesn’t mean it’s impossible to get a home loan.

Here are some steps to improve your credit and other options you may have.

According to the Fair Isaac Corporation, a brand of credit score known as FICO used by lenders to determine a borrower’s creditworthiness, your number is calculated by analyzing five categories: payment history, amounts owed, new credit, length of credit history and credit mix. 

FICO credit scores range from 300 to 850. The higher your credit score, the less risky you appear to lenders, and vice versa.

Here’s what’s considered a “good” and “bad” credit score, according to FICO:

Government-sponsored enterprises like Fannie Mae and Freddie Mac require a credit score of at least 620 to be eligible for a conventional loan. Some lenders require an even higher score.

Government-backed loans are less credit-sensitive, with lower qualifying requirements, and easier for buyers with bad credit to qualify. Loans from the Federal Housing Administration require a 580 score to qualify for a mortgage with a 3.5% down payment but can go as low as 500 for a loan with a 10% down payment.

“Lenders prefer to see a credit score of 620 or higher, but loans can still be approved for scores below 620,” says R.J. Weiss, a certified financial planner and founder and CEO of The Ways to Wealth. “Other factors, such as a favorable debt-to-income ratio, can help you get approved, but this is highly variable per lender.”

Although you can buy a house with a “bad” credit score, lenders will try to offset the potential risk by offering you higher interest rates.

“When you're late on payments, or stop making payments on a loan, that's costly to lenders,” says Aaron Gordon, head coach and branch manager at Guild Mortgage. “The better your credit, the lower the risk of you going late or into default, the lower the interest rate. The worse your credit, the higher the risk of you going late or into default, the higher the interest rate.”

In other words, some lenders may not approve you if your credit score is too low, while others may offer you a mortgage at a higher interest rate.

You may want to consider improving your score before applying for a home loan to increase your chances of loan approval or to secure a more favorable interest rate. 

Keep in mind that it could take some time to improve your credit score. “It can take anywhere from a few months to a few years to improve a bad credit score. It depends on how much bad credit you have and how long you've ignored it,” Gordon said. “However, there is no credit score that's so bad it cannot be improved substantially over time.”

If you have a bankruptcy on your credit report, Weiss says any meaningful improvements are unlikely until it’s removed, which typically takes seven years. Also, collections can remain on your report for seven years, Weiss adds, but their financial impact diminishes over time.

Over 10 million Americans filed bankruptcy and/or lost houses to foreclosure during the Great Recession from 2007 to 2010, according to Gordon. “Your credit doesn't get much worse than that. Many of those folks rebuilt their credit and were buying houses within two to five years,” Gordon added.

Several mortgage options are available to borrowers who want to purchase or refinance a home, even with bad credit. Here are the most common home loans for bad credit.

A conventional mortgage isn’t insured by the government, and it may be more difficult to qualify for a mortgage if you have poor credit. Government-sponsored enterprises Fannie Mae and Freddie Mac require a credit score of at least 620 to be eligible for a conventional loan, but some lenders require an even higher score.

“Some could decide their minimum is 640 or even 680,” Gordon says. “That's another reason why it's important to shop between two to three lenders.”

One of your best bets if you have bad credit is an FHA loan backed by the Federal Housing Administration. Government-backed loans are less credit-sensitive, and due to lower qualifying requirements, it’s often easier for buyers with bad credit to qualify.

Although you may qualify for an FHA loan with a bad credit score, there are other considerations to take into account.

“For government-backed FHA loans, approval is possible with a credit score as low as 500, but this requires a 10% down payment for scores between 500 and 579,” Weiss says. “For those with a credit score of 580 or higher, the minimum down payment is 3.5%.”

VA loans are backed by the Department of Veterans Affairs and are available to service members, veterans or qualifying surviving spouses. The VA does not require a down payment or a minimum credit score, but most lenders do.

According to Gordon, some lenders may consider a credit score as low as 500, but this depends on the lender’s risk tolerance. Other lenders typically have a 580 minimum credit score requirement.

Backed by the Department of Agriculture, the USDA loan is another zero-down-payment mortgage that allows you to purchase a home in a qualifying rural area. Many lenders require a minimum credit score of 640, but a 620 may work for others.

You can potentially qualify for a mortgage loan with bad credit, but it’ll take some time and the right strategy.

1. Build a strong financial profile. Do what you can to improve your credit score before filling out a mortgage application. Pay down debt, save money and prioritize paying all of your bills on time each month.
2. Find a lender that specializes in bad credit. “Most mortgage loan officers love helping people create homeownership,” Gordon said. “Many have a credit repair or credit restoration expert they work with. They will work with you on a strategy to rebuild your credit. If they don't offer this, find a loan officer who will.”
3. Shop around. Some lenders offer lower rates than others, which can potentially save you thousands of dollars over the loan term. 
4. Find a co-signer. Having a co-signer on your mortgage can help you qualify even if you have a bad credit score. Keep in mind that the co-signer must also be willing to take on the loan if you should default.
5. Save up for a larger down payment. And as with most real estate transactions, cash is king. Consider saving up for a larger down payment to reduce the amount being borrowed. 

Here are some tips to improve your credit score.

• Review your credit report: This allows you to spot any inaccuracies and dispute them with the three major credit reporting agencies: Experian, Equifax and TransUnion.
• Pay off debt: Reduce your credit utilization as much as possible. “Pay down credit card balances below 30%,” Gordon said. “Clear up or settle collections and older disputed accounts.”
• Pay your bills on time: Always pay all of your bills on time. Your payment history accounts for 35% of your FICO credit score calculation, the highest percentage of all categories.
• Increase your available credit: To raise your credit score faster, you can increase your available credit to reduce your credit utilization. “This also helps reduce your debt-to-income ratio, one of the main things lenders focus on outside your credit score,” Weiss said. You can do this by either paying down balances or requesting a credit limit increase on your credit cards.
• Don’t close older accounts: Keep your credit accounts open to improve the length of your credit history.
• Report rent and utility payments: If you lack credit history and always pay your rent and utilities on time, consider reporting these to the three credit bureaus. You can do this by asking your landlord or utility companies, or by using a third-party service.
• Minimize hard credit inquiries: Avoid taking out new loans before you buy a house. According to FICO, one hard inquiry, such as a car loan or opening a new line of credit, will temporarily bring down your credit score by five points.
• Understand your debt-to-income (DTI) ratio: Your DTI tells lenders if you can afford to take on additional debt. A high DTI can signal that you have too much debt compared with your monthly income. Generally, most lenders require a DTI of 43% or less to qualify for a conventional loan, but this depends on the lender.
• Consider credit counseling: These are typically offered by nonprofit groups, and certified and trained counselors can advise you on money and debts, budgeting and help organize a debt management plan. They’ll also provide a copy of your credit report and scores and offer free educational materials and workshops. Don’t forget to ask about fees before making a commitment.
• Get preapproved: Not only does a mortgage preapproval show the seller that you’re a serious buyer, but it also lessens the chance of your financing falling through and helps speed up the mortgage process.

Here are some frequently asked questions people have about getting a home loan with bad credit.

What is considered a good credit score for buying a house? A good credit score for buying a house is 620 or higher for a conventional loan; however, some lenders may have a higher minimum credit score. Government-backed loan programs are typically more lenient, and some lenders require a credit score as low as 500 for FHA and VA loans.

How can I increase my chances of getting approved for a mortgage with bad credit? You can increase your chances of getting approved for a mortgage with bad credit by taking action and improving your score. Saving for a bigger down payment and using a co-signer can also improve your chances of getting approved for a home loan.

What are the risks of buying a house with bad credit? Although you may qualify for a mortgage, there are risks to buying a house with bad credit. Many traditional lenders may not offer a loan to you, and if they do, there may be higher down payment requirements and a higher interest rate. A higher rate will raise borrowing costs and increase your monthly mortgage payment.

Are there government programs to help people with bad credit buy a house? If you’re looking to buy a home, there are several government programs that help people with bad credit. Government-backed mortgages have more lenient credit requirements than conventional mortgages. Some borrowers may qualify for a home loan with a credit score as low as 500.

This story was updated on April 9.