How to Buy a House With Bad Credit But Good Income

How to Buy a House With Bad Credit But Good Income

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A home represents a large financial purchase for U.S. consumers. Last year, the national median home sales price was roughly $386,000.

Based on the price, most consumers must finance a home purchase through a mortgage loan. Those with bad credit might struggle to qualify for a mortgage or face less favorable loan terms.

Yet, those with stable income and some cash on hand for a down payment will have more options.

How to Buy a House With Bad Credit But Good Income

There are a few things that you can do to buy a house with bad credit:

  1. Offer a large down payment (10-20%)
  2. Get a government-backed loan (like FHA)
  3. Apply to many different mortgage lenders

Consumers with bad credit usually have more difficulty in obtaining mortgage loan approval. So realize that you will have to pay higher interest rates

What Is Considered a Bad Credit Score By Mortgage Lenders?

Estimates suggest that roughly 90% of lenders use FICO Scores as a basis for decision-making. Credit scores are numeric and range from 300 to 850. The following table shows the approximate ranges. 

FICO Score Ranges

Score RangeCredit Rating 
800 to 850Excellent
740 to 799Very Good
670 to 739Good
580 to 669Fair
300 to 579Poor

Source: FICO

The three major credit reporting bureaus are Equifax, Experian, and TransUnion. These organizations compile any reported information from lenders that form your credit history. FICO and VantageScore then use the credit history data in their scoring calculations.

Some lenders may only report to one or two of the credit bureaus. For this reason, a consumer might notice variations in their credit score. In these scenarios, lenders might make decisions using the median or average credit score of each credit bureau.

According to Experian, mortgage lenders might also look at models according to guidelines. For example, those specified by Fannie Mae or Freddie Mac, which regulate government-backed options.

Is It Possible to Buy a House With Bad Credit?

Buying a home with a low credit score is sometimes difficult–but certainly possible. As with any large purchase requiring financing, checking your credit is a key first step.

Consumers may receive a free copy of their credit report each year. This is an excellent starting point for a couple of reasons.

First, you may identify errors in your report that are hindering your score and correct them. Also, you get an understanding of where you currently stand and can set goals for improvement.

Knowing your credit score will also help you navigate your mortgage options. For example, with a sub-500 score, you are likely better off working to improve your score first. With a 500 or better score, you will likely have (albeit limited) mortgage options.

In the short term, eager homebuyers should work to boost their income and accumulate a down payment. Also check out our article, How Much Credit History Is Needed to Buy a House?.

Financing Options You Have With Bad Credit:

Consider the following four options for mortgage financing. 

Conventional Loans

Conventional mortgage loans typically make up 70 to 80% of the home loan market. Conventional loans are usually obtained through banks, credit unions, and other private lenders.

Conventional loans are not backed by government agencies. Yet, “conforming” loans meet guidelines from Fannie Mae and Freddie Mac. Created by Congress, “Fannie” and “Freddie” assist and stabilize the market.

Borrowers usually need a credit score of at least 620 and a debt-to-income ratio below 43%. For the protection of lenders, borrowers must have a down payment of 20%. 

When lacking a 20% down payment, borrowers must maintain private mortgage insurance (PMI). Annual PMI costs often range from .5% to 2% of the loan amount.

FHA Loans

The Federal Housing Administration backs FHA loans. Qualifying for an FHA loan requires a 500 to 580 credit score and a 3.5% to 10% down payment. Further, your debt-to-income ratio must not exceed 43%. The formula for debt to income (DTI) ratio is:

DTI % = the sum of all monthly debt payments / gross monthly income

Also keep in mind that FHA lenders often require that you resolve any active collection accounts or judgments.  

VA Loans

VA loans are federally guaranteed by the U.S. Department of Veterans Affairs. Those eligible for VA loans include military members, military veterans, and surviving spouses.  

Approved lenders offer VA loans, which are largely seen as a benefit or perk of military service.   Thus, VA loans often have no down payment requirements and favorable interest rates.  Applicants must show a Certificate of Eligibility (COE). 

VA lenders have some flexibility in their requirements. The basis for approval is often known as a borrower’s “overall risk profile.” Many VA loan issuers will only approve applicants with a debt-to-income ratio below 42%.

USDA Loans

The United States Department of Agriculture (USDA) is a federal agency. The USDA backs mortgage loans for low-income individuals in rural settings.

The USDA has a variety of mortgage loan programs including those for single-family homes. Qualified applicants are U.S. residents or national or permanent resident aliens.

Properties financed with USDA loans are in certain rural areas. Applicants must have an adjusted gross income of less than 115% of the local median. This website tool calculates these details.

Lenders assess whether applicants have steady and sufficient income. Most lenders issue loans only to those with at least a 640-credit score and a debt-to-income ratio below 43%.

How Does Bad Credit Affect Your APR?

Mortgage interest rates change based on several market variables. Business or financial resources will regularly post updated current mortgage market interest rates. 

While market rates represent a good indicator, personal factors also influence the rate you receive. For example, your credit score, debt-to-income ratio, and down payment.

The term “APR” refers to the loan’s annual percentage rate. The APR is the average annual amount of interest you will pay throughout the loan term.

The following table illustrates the impact that your FICO credit score has on your APR with a 30-year fixed-rate mortgage.

FICO Loan Calculations

Loan PrincipalFICO ScoreAPRMonthly PaymentTotal Interest Paid
$ 300,000760 to 8506.24 %$ 1,846$ 364,553
$ 300,000680 to 6996.64 %$ 1,925$ 392,822
$ 300,000640 to 6597.29 %$ 2,059$ 439,463
$ 300,000620 to 6397.83 %$ 2,166$ 479,929
$ 400,000760 to 8506.24 %$ 2,461$ 486,071
$ 400,000680 to 6996.64 %$ 2,566$ 523,762
$ 400,000640 to 6597.29 %$ 2,739$ 585,950
$ 400,000620 to 6397.83 %$ 2,889$ 639,905

Source: FICO

The total interest paid column demonstrates how your credit score might have a substantial overall impact.

Things You Can Do to Increase Your Credit Score

Let’s look at some credit improvement options and best practices.

Get a Credit Builder Loan

A credit builder loan deviates from a standard installment loan. Here, the loan funds remain secured in a bank account during the term.

Borrowers pay fixed monthly payments, which the lender reports to the credit bureaus. After making all payments, the borrower may access the original loan funds. Credit builder loans often have 12 to 24-month terms and often range from $1,000 to $2,000.

Increase Your Available Credit

Increasing your credit card limits is a possible quick way of boosting your credit. This occurs by improving your credit utilization rate, which should remain below 30%. 

For example, if you have a $500 balance on a credit card with a $1,000 limit, your rate is 50%. If you contact the card issuer for an increase to a $2,000 limit and get approved, your rate is 25%.

Dispute Inaccurate Data on Your Credit Report

Another possible quick means of improving your credit is correcting credit report errors. All three major credit reporting bureaus have easy-to-use website applications for disputing errors.

Stay Away From Hard Credit Inquiries

A hard inquiry occurs when lenders, employers, landlords, or others might check credit scores. Equifax confirms that hard inquiries appear and remain on credit reports for up to two years. 

Fortunately, the adverse impact on your FICO credit score is minor and only lasts for up to one year.

Securing a mortgage loan for a home with bad credit is possible, with a steady income and a good down payment. The primary drawback is that you will likely face higher interest rates that really add up.

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