Home loans for people with bad credit are surprisingly available. If you have had credit challenges in the past and want to refinance or buy a home, you have options. There are excellent loans such as FHA and VA loans that give you the opportunity to buy or refinance a home even if you have bad credit.
Here is what we will be going over in this article:
- How lenders rate credit based on FICO scores
- Best home loans for bad credit
- Bad credit loan options to be cautious of
- What you can do to improve your credit
#1 How Lenders View Your Credit Based on Your Credit Score
FICO credit scores range from 300-850. Interestingly enough, 33% of the US population has credit scores that put them in the fair to poor credit category. 46% of Americans have good to very good credit, and 21% have exceptional credit scores.
Here is how the different ranges of FICO scores classify creditworthiness.
- 300-579 — Poor Credit
- 580-619 — Fair Credit
- 620-719 — Good Credit
- 720-799 — Very Good Credit
- 800-850 — Excellent Credit
You will find that most home loans offer decent interest rates starting with FICO score of 620. The higher your credit score is, the better the rate is. Additionally, for some types of loans, FICO may determine how much down payment you need to buy a home. For those looking to refinance, FICO may limit how much of the value of your home you can borrow against.
#2 Best Home Loans for Bad Credit
Federal Housing Administration (FHA) loans are, without a doubt, the best options for borrowers with bad credit. FHA insures the loans that lenders make to borrowers, which gives lenders an added level of comfort in knowing their capital is safe.
FHA loans are typically available with FICO scores as low as 500 if you put 10% down. If your FICO score is 580 and above, you may qualify for FHA with just 3.5% down payment. Interest rates are higher for FICO scores below 640, but at least this gives you an opportunity to buy a home or refinance while you work on your credit.
If you happen to be a veteran, you are in luck when it comes to home loans. The Veterans Administration (VA) actually does not have a minimum FICO requirement to qualify for a VA loan. However, lenders who make these loans have what is known as “overlays,” which are the lenders’ own requirements to approve a VA loan.
Most lenders require a 620 or above FICO score to be approved for a VA loan, but you will find there are lenders that will go as low as 580 FICO.
The United States Department of Agriculture (USDA) offers flexible credit home loans to purchase a home in designated rural areas. USDA does not require a minimum FICO score, although lender overlays usually place the minimum FICO at 620 to get approved through the USDA Guaranteed Underwriting System (GUS).
Borrowers with FICO scores below 620 may still receive a loan approval through manual underwriting. This is a process where an underwriter will review the file in its entirety, and if there are enough merits, they can approve the file manually.
#3 Bad Credit Loan Options to Be Cautious Of
When you search for options for bad credit home loans, you will come across certain loan products that may not be advantageous for you. Even after the overhaul of the mortgage industry back in 2010, when congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, there are still home loans that can be risky for borrowers.
Private Home Loan Financing
The riskiest of loans you may be offered is a private home loan made by unscrupulous investors. As rates rise and demand for housing grows at seemingly unstoppable rates, you may come across homes sold with “seller financing”. Although there are legitimate opportunities you can capitalize on when a seller offers to finance, you need to approach these with caution.
Institutional lending is safe due to the extensive oversight and regulation by the government. Private financing, on the other hand, is mostly unregulated. This means that you have little recourse if the loan that a private investor offers you causes you hardship. If you consider these loans, consult with a Real Estate attorney, and do not go at it alone.
Non Qualified Loans are loans that are equivalent to sub-prime loans of the past. These loans are usually for investment properties, although some borrowers find ways to use them for owner-occupied properties.
NON-QM loans are for savvy investors with a clear strategy to use alternative financing to make a profit, usually from flipping homes or renting them out. They are not meant for people who are not financially astute.
#4 What You Can Do to Improve Your Credit
If you want to buy or refinance a home and your credit is preventing you from getting a home loan, there are some simple, low, or no-cost strategies you can use to give your score a quick boost. This may just raise your score enough so you can get a home loan when you wouldn’t otherwise be able to.
A great place to start is pulling your own credit report from any one of a dozen places that offer that as a free service. Once you have your report in hand, here are the most critical items that you can have a quick influence on to improve your score:
Utilization of available credit
Look at your revolving credit balances and look for accounts where you are using more than 50% of the available credit. This is a huge contributor to your FICO score and, in many cases, an easy fix.
For example, you may have a couple of credit cards with low credit limits, such as $300, which are very common. If you are using $200 of the $300, your score takes a big hit. It doesn’t take much to bring that balance down to $100 dollars which will improve your score considerably.
Inaccurate information on your credit report
A study by consumer reports found that more than one-third of people who volunteered to review their credit reports had errors on their reports. Some of the errors were significant enough that they had to take high credit loans when they did not have to.
Review each trade account on your report; if there are any late payments or open accounts that you do not think are accurate, you can file a dispute to have the reporting agency verify the information. The Fair Credit Reporting Act (FCRA) gives you the right to dispute any inaccurate information.
Related reading: How to Overcome Common Barriers to Mortgage, Part 2: Your Credit Report
Not enough open tradelines
FICO scores rely on enough data to establish a pattern of good payment history. If you don’t have enough open accounts, your score will be hampered by not having enough information to go on.
One quick and easy fix is to be added to someone’s account. Maybe a spouse or a parent has open credit cards with good payment history, low balances, and high available credit. Have them add you as a user to the account. Your credit report will update in a month or two, showing the new tradeline, and the FICO score algorithm will take it into account, boosting your score.
Any open collection accounts will hurt your credit. WARNING: Before paying off a collection account, consider that when you do that, the tradeline is updated, and it may hurt your credit to pay it off now. You may still need to pay it off to get a home loan; just know the impact this could have if you pay it off before getting a home loan.
You may come across old paid collection accounts that still show a balance; make sure those are updated or deleted from your report by disputing the information with the reporting agency.
The Bottom Line on Bad Credit Home Loans
Buying a home is possible even if you have bad credit. The government and other institutions promoting homeownership have made it possible for those who want to buy a house to realize that goal.
Bad credit home loans are not the dream loan, but they do let you get your foot in the door of homeownership. They can also help you with a refinance you may not be able to do otherwise. The good news is that you don’t have to keep that loan forever; you can refinance to a better loan when your credit improves.