As much as we may hate it, numbers can determine much of what we’re able to do in life. Just like a high grade point average is necessary to get into the college of your dreams, a high credit score is required to secure a loan on your dream Portland home.
And numbers don’t always reflect your pre-determined qualifications realistically. Similar to how you might be a poor test-taker in school, a one-off financial mistake can affect your credit score, and be hard to recover from.
“Today, bad credit isn’t just based on a number, but timing of recent derogatory activity like rolling late charges or a recent short sale or foreclosure,” says Joshua Vales, a mortgage loan originator with Mountain West Financial.
Bad credit extends beyond the three-digit score we tend to use as our financial report card. But hope is not lost if you’re wondering how to buy a house with bad credit. Here are a few ways you can position yourself and your finances to improve your chances of landing a loan.
- Save a larger down payment
- Go with a FHA loan
- Know what to emphasize to a lender
- Try a private mortgage
For those with a credit score below 580, a larger down payment is a necessity — not an option. However, potential buyers with scores in a slightly higher range could still benefit from offering more cash upfront to compensate for a low score. This would likely mean a down payment of 20% of the home value or higher.
A large down payment signals to the lender your ability to shoulder the loan despite a lackluster credit history, increasing your equity immediately and lowering your loan-to-value ratio. Even if your credit score is less than stellar, the more you have invested in the home, the less likely you are to default — and the less risk you pose to the lender.
When presented with borrowers carrying low credit scores, Vales points them in the direction of FHA loans — those backed by the Federal Housing Administration. The guidelines for FHA loans tend to be much more lenient than loans issued by Fannie Mae and Freddie Mac, which provide financial products and services to make homeownership more affordable for low- and moderate-income borrowers.
According to the Department of Housing and Urban Development, the organization that oversees FHA loans, borrowers can be approved for a FHA loan with a score as low as 580, as long as they are able to put down at least 3.5%. Conventional loans, on the other hand, require scores in the 620 or 640 range. But, while FHA loans may appear to offer competitive rates, they do often come with underlying higher fees attached.
While many lenders use automated systems to automatically determine whether you are a good loan candidate, you’re not out of the game if you’re deemed ineligible. Lenders do have the ability to go the manual underwriting route, setting a low score aside if you can demonstrate financial stability in other ways.
For instance, showing on-time rent payments for a year or more, or cash reserves of at least six months will help portray you as a less risky loan candidate. In addition, be prepared to explain why your score is so low to begin with. While a large amount of consumer debt in default can signal irresponsible spending and use of credit, medical and student loan debt can tell a different story entirely.
Large financial institutions might be the first place you think of to get a loan, but there are less conventional means to get a loan with bad credit — such as a private mortgage. Private loans can come from any party with the available funds to pay for your home purchase in full, upfront — e.g., a family member, friend, or private lender. You then pay for the home based on terms agreed upon by both parties. While there are plenty of risks to this type of transaction (potentially high fees and a high probability of relationship turmoil), it essentially makes your poor credit a moot point.
The bottom line? Poor credit doesn’t mean homeownership is out of reach
“We never just tell a client who has a goal of homeownership ‘no.’ We may say ‘not yet,’ but that is always followed up with a detailed plan on how to fix [their] credit, save money, and gear up for homeownership,” says Vales. So while a low credit score might change the path to your goal of homeownership, don’t worry – you’ll get there eventually!
What advice would you give to someone with less-than-stellar credit who wants to buy a home? Share your tips and experiences in the comments!