Home buying with bad credit might be a little challenging but not impossible. Today, mortgage lenders across the nation approve applications for first-time homebuyers with poor credit scores. The hack is spending a little more time planning and preparing before you embark on house hunting. But first things first: what is considered poor credit?
According to CNBC, anything below a 670 FICO is considered poor, bad, or below-average credit. A 670-699 credit score is deemed to be fair, while a poor credit score ranges from 300-579. People with excellent, good, and fairly good credit records can easily access virtually any mortgage loan they need at better and lower rates. But just because yours is a bad credit record does not mean that you should give up on your desire for homeownership. Here are some valuable things to know when home buying with bad credit.
1. Plan Your Budget
Before you start exploring and choosing a house out of your price range, you might want to define what you can comfortably afford. You also want to ensure that you don’t spend too much of your income on mortgage and leave nothing for other expenses. You should dedicate no more than 28% of your annual gross income to your mortgage as a good rule of thumb.
For instance, if you earn $100/year, you might want to find a house whose mortgage costs a maximum of $28000. When home buying with bad credit, it is essential that you consider other prospective home-based expenses. For example, if you go for a fixer-upper due to its cost-effectiveness, consider the potential improvement costs. By doing so, you will not need to handle surprise expenses.
2. Save For a Significant Down-payment
When you decide to buy a home with bad credit, ensure that you save up for a significant down payment. With a bad credit record, you can only qualify for lower loan amounts. However, putting a large amount of money towards a down payment can guarantee a higher sales price. You can learn more about this at Bills.com.
3. Brace Yourself for Higher Interest Rates and Monthly Payments
One of the main downsides of home buying with bad credit is that it will eventually cost you more. Generally, the lower your credit score, the higher your mortgage interest rate. This is because lenders consider the FICO score signals a borrower’s responsibility. Besides, if your down payment is below 20% you will have to pay for the monthly mortgage insurance. These brought together translate to higher monthly mortgage payments than people with an excellent credit score.
4. Strive to Clear Other Loans
Other things might be more important to your lender than your credit score, including the debt-to-income (DTI) ratio. This compares your total monthly debt repayments to your monthly income. This will give the lenders a clearer picture of your total debt amount and how much income you can dedicate to your general monthly expenses.
To calculate your debt-to-income ratio, add all your monthly date payments, including student loans, credit card payments, car loans, and future mortgage payments. Then, divide all this with your total monthly earnings to get your DTI ratio.
Generally, most lenders prefer debt to income ratios below 36%. If you are struggling with heavy debts and huge monthly burdens, it is essential that you strategize on clearing the loans before you settle on home buying with bad credit. Clearing your debts will look good to your lender, will reduce your DTI number, and will help enhance your credit score.
5. Take Advantage of an FHA Loan
An FHA loan is backed by the Federal Housing Administration (FHA), which exists to make homeownership possible for people who might find it hard to secure a conventional loan. They are an excellent option for first-time homebuyers, given that they have lower down payment demands than private institutions. To qualify for an FHA loan, your credit score must eat at least 580 with a down payment of 3.5%. If your credit score ranges from 500 to 579, you need to put down a 10% down payment to qualify for an FHA loan. When home buying with bad credit, paying a 20 percent of the ultimate price is a great move due to the following reasons:
- Loan to Value Ratio
Loan to value ratio compares your loan amount to your home value. For instance, you buy a home worth $150000 and pay $30000 (20%) as the down payment. In this case, the new mortgage loan amount will be $120000. When you compare the loan amount to the home’s value, you will get 80 percent. Let us say you only put down $15000, so 10% is the down price. Your loan to value ratio will be 90% which most lenders don’t like. People with less equity in their homes are more likely to default on loans. If you have a higher LTV, you might be charged a higher interest rate.
- Private Mortgage Insurance
If your loan to value ratio is above 80%, you might also need to pay Private Mortgage Insurance (PMI). Ideally, this insurance is designed to protect the lender from loan defaulters. An LTV above 80% is considered a high risk which is why you are required to pay to be insured. This does not mean that you must put down a 20% down payment. If you can pay a lot of rent money each month, home buying with bad credit might be cheaper for you, even with PMI and the crazy interest rates.
6. Check Whether You Can Access a USDA or VA Loan.
If you are a lower-income home buyer or a veteran living in a USDA-eligible rural area, there are other two types of credit-flexible loans at your disposal:
- USDA-loan program
The United States Department of Agriculture offers this loan assistance. It is meant for people earning moderate-income in USDA-eligible rural areas. No down payment, credit score, or PMI is needed as the lender tends to focus on other sections of your financial history.
- VA Housing Loans
These loan services are available to veterans, service members, and surviving spouses who are home buying with bad credit. Some of the benefits include strong government backing, competitive interest rates, and low to no down payments.
What’s more, the ultimate credit score requirements might vary with the lender. All the same, lenders are required to analyze the borrower’s entire loan profile and should not deny loans based on credit scores alone.
7. Work on Your Credit Score
As aforementioned, your credit score will significantly determine your mortgage interest rate. If you don’t commit to improving your credit score, your interest can quickly accumulate to tens of thousands of dollars.
That said, you might want to prioritize enhancing your credit score before you venture into owning a home. Be sure to take a step at a time and expect to see significant improvements. You will be one step ahead in attaining the best interest possible based on your new scores.
Home buying with bad credit is possible if you follow these brilliant steps. Sure, you might not own a house overnight, but you can make it a goal and work towards achieving it.
Even better, it will be a great way of building better credit.