Sometimes, it can feel like the deck is stacked against you. You’ve been told you have “bad credit” and that means you’re having trouble getting a traditional mortgage loan.
But wouldn’t getting off the rent cycle treadmill be a first step to rebuilding your finances?
What’s worse is that bad or poor credit could mean so many things: a low credit score, a short credit history, a recent job change and so on. Even open credit report disputes can make a mortgage lender say no — I once had to pay an incorrect medical bill just to get a mortgage.
That was as irritating as it was costly, but at least it could be fixed fairly fast. The bad news is that when it comes to being flagged as having “bad credit” — even just having a credit score below 640 — several of the causes can’t be fixed without potentially waiting years for your score to rise.
Why Bad Credit Is Such an Issue for Getting a Mortgage
First of all, it’s important to know what constitutes “good” and “bad” credit. When lenders query the credit bureaus (like Equifax, TransUnion or Experian), they’re given a full credit report made up of details like your payment history, your total debt load, how much unused credit you have, and more.
All of those things work together to calculate your credit score, which is an estimate of how likely you are to repay any new loan on time. If your score is low, you’re considered high risk.
Remember that lenders are in the business of making money, and someone who defaults on a loan is a major issue for them. When it comes to something like a mortgage, when you’re borrowing hundreds of thousands of dollars, a high risk borrower can mean even bigger trouble.
The good news is that in 2019, there are still many ways to buy a home with bad credit.
How to Buy a House with Bad Credit
Some might seem like common sense, but remember that even simple solutions can have major benefits! Without further ado, here are 5 options open to the home-buyer with less-than-optimal credit.
1. Save for a Larger Down Payment
Sometimes your credit is only part of the problem. What can make it even harder are the debt-to-income ratio rules.
Lenders want to see you using less than 43% of your income for all debt repayment. That includes your credit card debt and any other debts you might be carrying, so it helps to pay those off first. But what if your mortgage payment alone is still above the 43% mark?
A simple solution is to start saving.
With a larger down payment, you’ll need to borrow less, which lowers your loan payments, and can give lenders more reason to look favorably on your loan.
A good place to aim for is a down payment that’s at least 20% of the purchase price of the home. Not only will this give you a better chance of getting a mortgage, but with that loan-to-value ratio, you can also avoid private mortgage insurance (PMI), further lowering your payments.
2. Borrow Privately
This is, admittedly, a tough situation to think about, but if you’re desperate to move into a place of your own, it makes sense.
The people who know you best would obviously know better than a bank if you’re a good credit risk — and they may be more forgiving of an occasional late payment.
They also won’t charge you loan fees and can be more flexible about terms.
And the advantages of borrowing from family for a home go both ways. Parents or siblings might appreciate making a decent return on their money compared to what’s available from savings accounts.
Of course, that’s only if you’re extremely vigilant about your payments. No home-buying timeline is worth alienating the people closest to you.
At the same time, there are also seller-financing options. This might be more elusive than borrowing from family, but if you have the wherewithal to research the types of seller financing (mortgage, lease option, contract for deed, etc.), you could deal directly with the current homeowners. Keep in mind, though, that you may pay a higher price overall and even a higher interest rate.
3. Get a Co-Signer
If you’ve already approached someone close to you to help, but they’re uncomfortable actually lending you the money, there’s another option: getting them to co-sign the loan.
The primary advantage to this is that the co-signer’s income will be considered in determining how much you can borrow.
This might be exactly what you need if your problem is a business for which you don’t yet have two years of tax returns, or if you have other income you can’t use to qualify, such as capital gains income, or investment income you haven’t been receiving for at least two straight years.
That said, having someone with good credit co-sign on your mortgage loan will not completely cancel out your bad credit, according to TheMortgageReports.com. Lenders will still consider your low credit score or other credit problems.
Unfortunately, there’s a major downside for your co-signer as well: Being a co-signer to a loan of that size could affect their credit. In the worst case scenario, if you default on your loan and go into foreclosure, their credit will undoubtedly suffer major setbacks.
4. Look into an FHA Mortgage
Most conventional home loans are held privately, by lenders like banks. In the United States, though, there is a government-backed option from the Federal Housing Administration (FHA), dedicated to home buyers in situations just like this one.
There are several differences between a conventional loan and an FHA loan, but one of the biggest is the rules about credit. If you have a credit score over 580, you can get an FHA mortgage if you can make a down payment of 3.5% of the total value of the home. For a $100,000 house, that’s $3,500.
If you have a credit score under 580, you can still get an FHA mortgage if you can make a down payment of 10% of the total value of the home. That might seem like a lot of money to save up, but when compared with the difficulty of repairing your credit, it can actually be a lot easier.
And if your job history is a problem, an FHA loan might be able to help. Lenders who issue FHA loans look at a number of factors to determine your “probability of continued employment,” and you don’t always need the traditional two years of employment to qualify.
Going this route does mean a bit more hassle, though. FHA loans are required to have a specific kind of insurance called Mortgage Insurance Premiums (MIP), and unlike a conventional mortgage, these never expire and will have to be paid for the life of the loan. That means added costs every month, which can limit the amount of home you can afford.
5. Other Options
If you’ve exhausted this list and you still need other ways of potentially becoming a homeowner, there are still some avenues left to you… they just might not be the easiest of solutions.
Remember that it’s always worth thinking outside the box. For example:
Buy a House for Cash
It’s not that far out of the realm of possibility! I’ve made it work and there are plenty of ways to make what seems like a pipe dream much more palatable.
Buy a Cheap Mobile Home
Mobile homes have their advantages, including lower prices than site-built homes, which is great if you have to pay cash. Plus, if you buy a mobile home on land, you even get appreciation like you do with other homes.
Shop Around for Loans
Most banks either sell home loans or want the option to do so, which means meeting the requirements of the secondary mortgage market.
But some small banks and credit unions keep loans in their portfolios because the loans have more flexible qualification rules. Ask around to see which banks keep loans and are willing to look at the whole picture, rather than a bad mark or two on a credit report.
Improve Your Credit
OK, so it’s not a quick solution. But improving your credit is always a good idea, and if you can wait a few more years to buy a home, you might even be able to save up more money to afford something better.
Start by looking at how to raise your credit score. Find the strategies most likely to work for you and implement them!
Steve Gillman is the author of “101 Weird Ways to Make Money” and creator of EveryWayToMakeMoney.com. He’s been a repo-man, walking stick carver, search engine evaluator, house flipper, tram driver, process server, mock juror, and roulette croupier, but of more than 100 ways he has made money, writing is his favorite (so far).