How to Buy a House with Bad Credit 101
Houses today are more affordable than they have been in many years, thanks to the collapse of the housing bubble a few years ago. Prices have declined in almost all areas of the country, and in some places they continue to decline to this day. Home prices in Las Vegas, Nevada, for example, are in many cases a whopping 70% less than they were at the height of the housing boom, with no end in sight.
This means that it should be easier than ever to buy a house, but unfortunately, the reverse is often true. The bad economy has forced many of us into making hard decisions that may have been right at the time, but ended up leaving black marks on our credit reports.
In order to take advantage of the great house prices now out there, the question often boils down to one issue: how to buy a house with bad credit.
It may seem like the American dream is beyond your reach, but that’s probably because you don’t know that many ways actually exist to buy a house with bad credit. Here are the top ways that you should learn about and keep in mind as you are house shopping:
- Buy a Home with A Large Down payment and Bad Credit
- Buy a House with Owner Financing
- Buy a House Through Lease Option
- Buy a House with Lease Option with Conventional Financing
- Buy a House with a Cosigner
- Buy a House through a FHA Mortgage
But first, before we look at how to buy a house with bad credit, let’s first talk about how to qualify for a home loan because this is the BASIS for buying a home.
How to Ensure You Qualify for a Home Loan
1. Know Your Credit History
This is absolutely important. Your bank/mortgage lender will be looking at your credit history/score, so you should know exactly where you stand and what’s on your credit history. There are two ways you can check your credit: the fast and easy way, or the long way. Either way works.
You can check your credit score online with this $1 Credit Check Offer by CreditScorePro.com or you can write a letter to all 3 major credit agencies and request your credit report t o be mailed to you. By the terms of the Fair Credit Act, you can do so once a year.
2. Get a major credit card
If you have a credit card, great. If you are in the position of say a bankruptcy, it’s likely any of your previous credit cards will have been canceled. You can try applying for regular credit cards with your bank (or directly from VISA/Mastercard), but it’s my experience that these sources are unlikely to give you a credit card. Credit card companies are leery of risk these days.
Even if you have bad credit, it’s possible to still get a credit card. Why am I talking about this in a “how to get a house with bad credit” guide? Because fixing your credit is essential to getting any sort of loan with good terms. Credit cards are one of the best tools you have for repairing credit.
How to Get a Credit Card with Bad Credit:
Look for those “Mall/Grocery Store” Credit Cards
You’ve probably seen these type of credit cards. Usually there is an annoying salesman trying to hawk a store credit card to you just as you are trying to walk out of a store. Normally I would say “ignore” these as the interest rates and terms offered on the card are dreadful, but if you have bad credit you are NOT in a position to be picky. Often these type of credit cards are given out more readily than regular credit cards.
Apply for a Bad Credit Credit Card
There are some online companies that will match you up with credit card providers willing to give credit cards to clients with bad credit. Of course, expect high interest rates on the card, but as a temporary card to be used to repair your credit history, it’s fine.
Get a secured credit card
These are basically fully functional credit cards. But the credit you have on the card is determined by the deposit you pay on the card. You will usually pay 500 or 1000 dollars as a deposit on the card. That money will then be the “credit” limit on the card. In one year (or two years, depending on the financial institution), your deposit will be returned to you and the card converted into a non-secure credit card.
There is a BIG difference between a secured credit card and the “prepaid credit cards” you might see on online ads. Prepaid credit cards DO NOT repair your credit and you must pay a “fee” to put money on the prepaid card. Both prepaid credit cards and secured credit cards will work anywhere VISA/MASTERCARD is accepted, but between the two a Secured Credit Card is a real credit card while a prepaid credit card is not. Let me restate: a secured credit card is exactly the same as a normal credit card, the only exception being that your account balance is whatever deposit you’ve put down on the card. You must “repay” whatever you’ve charged on the card at the end of the month just like a regular credit card.
So if all the other options for getting a credit card fail, then this is the one to choose. We have found that secured credit cards are not as easy to get as you might think, however. A number of readers have told us that banks will still reject your application for a secured credit card.
So where to apply for a secured credit card with a reasonable chance of getting one?
You can apply for a secured visa card online (they specialize in online secured visa cards) or you can go to your local bank to apply through your bank. Note that physical banks may reject your secured credit card application if your credit report shows you still currently owe money to people (i.e. your credit report doesn’t just have a low score but there there are marks saying you still have not paid debtors what you owe). If this is the case, your best bet is to apply for an online secured credit card as the credit check requirements are waived or just visit many different bank companies in person and apply and hope one will give you a secured credit card.
3. Never Ever Miss a Payment
If you are trying to repair your credit, the worst thing possible to do is to miss a payment of some sort. This could range from a credit card payment, phone bill, even a parking ticket. Anything that might lead to a negative mark on your credit must be avoided. Lenders want to see that you have a proven track record of paying your bills on time. This is also important because it leads up to our next point
4. Build “Non Traditional Credit History”
It’s true that mortgage lenders will look at your credit history, but they will also look at what’s called you’re “Payment History” (also called Non Traditional Credit History) too. Let’s go over this, since it is important.
First let’s give a definition of Non Traditional Credit history, or rather let’s let the government do it for us: In 2008, the Federal Housing Administration (FHA) put down a firm definition of non-traditional credit. Basically, non-traditional credit allows mortgage lenders to help establish a borrowers credit history through what you might call “non traditional means.”
This means that you can build a sort of ‘alternative credit history’ by making on-time payments to non-credit sources. The normal way to build credit are though “credit” sources such as credit card payments, car loan payments, mortgage loan payments, personal loan payments, etc.
However, Non Traditional Credit history can be build for some of the following sources:
- detailed payment history
- telephone bills
- utility bills
- cell phone bills
- cable TV bills
- local store credit cards
In short, paying your non-credit bills like cell phone bills, cable bills, utility bills can help you get a mortgage. Non traditional credit allows lenders to have an alternative means to determine loan worthiness. Note: this doesn’t mean you can just lax on your regular means of repairing and maintaining your credit (such as making loan repayments on time, credit card payments, etc), but if you have bad credit Non Traditional Credit can be a means to help you get a mortgage.
Note: you will need to keep a copy of all bills paid to prove your history.
5. Show regular employment for 1 to 2 years (preferably one job)
Mortgage lenders want to be certain that you can “pay” your mortgage. This is even more important now after the 2 year recession (some argue “depression”) that we’ve had. Lenders do not want to give out loans to someone who is likely to have problems repaying the home due to unsteady employment. It’s true that when the housing market in rising and rising, lenders are more willing to risk giving out home loans even to people who might not be able to pay the home off — if the person can’t pay, the home is foreclosed and the bank keeps the deposit paid AND can sell the house at a higher price.
6. Be able to show you earn wages or a salary
It’s not enough to show you have regular employment. You will also need to be able to prove you earn a wage. You might be able to show yourself as employed by your own company, but then your lender will want to see “how much you’ve made.” If you can show a steady salary over a couple years, you will be in a good position to get a mortgage loan, provided you have a down payment.
7. Save up a down payment of at least 10%
Having a down payment is highly recommended. Even if you have good credit, there is still a lot of benefits to putting down money on your home. For one, you lower the amount you owe on the home and thus bring down the interest amount you will pay. This saves a lot of money both in the short term and the long run. And secondly, having a down payment can help sway a lender to give you a mortgage loan, even if your credit history has been spotty over the years.
Now that we’ve given a list of things to do to improve your home loan qualifications, it’s also important to understand how important your credit score is and HOW it impacts what you pay for your mortgage.
Your FICO Score and It’s Effect on Your Mortgage
The relationship between your FICO score (i.e. credit score) is important to understand. If you don’t know your credit score, then you should check it to see where you stand right away. We recommend CreditScorePro.com’s $1 Credit Check Trial. You can basically get all 3 credit scores from the three main credit companies for $1 with this offer.
|730 – 850||Excellent|
|700 – 729||Great|
|670 – 699||Good|
|585 – 669||Average|
|300 – 584||Poor|
Now here’s what the difference between “good” and “average” and “poor” credit really means for you, should you actually get a home loan. Here is a chart of the effect FICO scores have on your mortgage interest rates:
- 760 to 850 tier 5.780%
- 700-759 tier 6.002%
- 660-699 tier 6.286%
- 620-659 tier 7.096%
- 580-619 tier 8.583%
- 500-579 tier 9.494%
Anything below 620 is considered “subprime” in fact. This means you are basically going to take a big interest hike. Even subprime interest rates differ, with the lower your FICO score, the higher your interest rates. If you have a credit score at the lowest levels, your home loan interest rate may well be in the double digits. A credit score of say 700 and a credit score of 500 could mean hundreds of dollars more a month in loan payments.
When looking at fico scores and trying to calculate your mortgage payments, it can seem pretty confusing. But put it this way:
- If your FICO score is 500-579, you are going to pay about 4 points higher than the best interest rates for mortgage.
- If your FICO score is between 580-618, then your interest rate will be about 2.25 points higher than the best interest rates for a mortgage loan
- If your FICO score is btween 620-659, your interest rate will be around 1.5 points over the top mortgage rates
- If your FICO score is 700-759, your interest rate will only be about .25 of a point over the best rate possible
- If your FICO score is 760-850, you have the best interest rate possible
How to Buy a Home with Bad Credit
And finally we come to the guts of the article. Let’s talk about how you can actually buy a home with bad credit or no credit.
Buy a Home with A Large Down payment and Bad Credit
Ok first off, if you have poor credit, it’s still in the cards for you to be able to purchase a home. Getting a home with bad credit used to be a breeze until 2007 when the economy started to crash. The type of “bad credit mortgage loans” given out were called sub prime mortgages. These type of loans are no longer easy to get.
But just because you don’t have good credit, does NOT mean you can’t purchase a home. Now, if you have a large down payment, it’s very possible to “sway” your mortgage lender into giving you a home finance loan. The lower your credit, the higher the down payment you’ll need.
If you are trying to buy a home after bankruptcy or foreclosure, this is a good option. For those who have declared bankruptcy or had a foreclosure, you will have to wait at least 6 months before any hard money lenders will give out a loan.
How much of a down payment will you have to pay if you want to purchase a home with bad credit? You can expect anywhere between 20% to 35% of the home’s value (I don’t give a definite because this changes). This is a hefty down payment to make indeed, but if you have bad credit but money saved up, it’s a sure way to get a mortgage loan. Note that the interest rate will be quite high (due to bad credit history) and your loan terms won’t be very favorable. There may be other penalties incurred as well.
Buy a House with Owner Financing
In general, it is banks and credit unions who pay a lot of attention to your credit history and FICO scores when you are trying to secure a mortgage.
Not all home loans require a bank to be involved, however. Some home sellers are willing to do what is called “owner financing.” This may sound like the owner is loaning you a sum of money, but what actually happens is that you agree on a purchase price with the house’s owner and set up a schedule for paying that purchase price over time.
This doesn’t mean that you won’t pay interest. The interest rate is one of the things that you will have to negotiate along with the purchase price. Most likely, you will pay a higher than average interest rate when you participate in an owner financing situation; this is because the house owner will be aware that you are probably working with him because you can’t get a bank loan. He’ll know that you are somewhat of a risk and increase the interest rate accordingly.
What he won’t usually do is actually check your credit record or ask the credit bureaus to supply your FICO score. As long as you can demonstrate steady, stable employment and an income stream that is sufficient to handle the payments you’ve arranged, the house owner will probably be satisfied that you’re not too much of a risk to take on.
After all, the risk on his end isn’t so very huge. If you fail to pay the loan, he will merely foreclose on you, which means he’ll get his house back and be able to sell it again. He’ll also probably be able to keep all the money you have paid for the house so far.
Owner financing used to be hard to find — most owners preferred for you to get a bank loan, since that way they would get the purchase price in full at once time. With owner financing, the owner will only be paid back over time, possibly as long as 30 years.
More and more owners are becoming willing to work directly with buyers in this market, though. That’s because of the dynamics of supply and demand. House prices are low because there are a lot more houses for sale than there are buyers at the present moment. Owners who want to sell are in the position now of having to compete for buyers by lowering prices and offering attractive terms. That includes the option of owner financing.
Pros of Owner Financing:
- Owners are more flexible than banks when it comes to arranging a payment schedule and loan terms. You might be able to arrange for an 18 year mortgage with an owner when banks will demand you agree to either 15 or 20, with nothing available in between.
- It may be the only type of financing you can get — without owner financing you would be locked out of the home market completely.
- Many types of bank fees are not involved in owner financing, so the overall cost of arranging the deal will be lower, sometimes much lower.
Cons of Owner Financing
- Some owners won’t do it, meaning that your choice of house will be more limited than it would have been with conventional financing.
- You will still have to come up with a down payment. Very few owners will agree to a zero down situation when they are assuming the loan risk for themselves.
- Your interest rate will probably be higher than you’d pay at a bank.
- A clear loan contract will be the responsibility of you and the owner, since no bank is involved. If the contract is not specific and clear enough, disputes could arise in the future about the purchase terms. This might snarl up your ability to fully assume title later and in the worst case scenario, could cause you to lose a home you’ve spent decades paying for.
- To avoid the problems listed above, it may be advisable to have a legal professional draw up the purchase agreement. This will add costs and possibly erase the “no bank fee” benefit you’ll get with owner financing.
Buy a House Through Lease Option
There are actually two methods to be examined in this category:
- Lease option with bank financing
- Lease option with owner financing
First let’s examine what a lease option is. A lease option refers to a special kind of rental contract in which you agree to rent a house for a period of time, most typically one or two years. During that period you pay rent just as would any tenant. However, in addition to your rent you pay a monthly fee that represents the “option to purchase.” This money builds up with the owner.
If at the end of your rental period, you decide to exercise your option to purchase, the owner must sell to you at the price and terms agreed years ago when you first became a tenant. Additionally, the money you paid toward the option now is used for the house purchase. It usually becomes part of your down payment, though it may not fully fund it.
If at the end of your rental period you decide you do NOT want to purchase the house, you are not obligated to do so. You didn’t sign a “lease-purchase” agreement, after all. It was just a “lease option,” which means you retain the option of turning the house down. If you DO turn the house down, however, you will lose all the money you have paid for the option. This boils down to accepting that you have paid extra rent for all those months.
Pros of Buying a House with the Lease Option Method:
- The option can give you an automatic way to save up for your down payment.
- You have a year, maybe more, to get to know the house and its mechanical systems before you must make a final purchase decision. You should be able to evaluate the house very accurately compared to someone executing a purchase without ever living in the house, first.
- Your time as a rental gives you a year or two in which to repair your credit history. This may not matter very much if the lease option contract specifies that you will have owner financing at the end of the rental period. It might say, though, that you are expected to get a bank loan at that time. The lease option time delay makes it more likely that a bank loan will be available, assuming that you take steps during the interim to improve your credit rating.
- You are able to cancel the purchase if the housing market has declined. In other words, if while you rented, the house value has gone down, you won’t be forced to purchase it at the price agreed on one or two years ago. This can help you avoid getting into an “upside down” situation in which you are paying more for a house than it’s currently worth.
- In some cases, if the house value has declined, the owner will want to sell it enough to renegotiate the option and lower the price of the house.
Cons of Buying a House with the Lease Option Method:
- Some owners will want the option money paid in full up front before you begin to rent. This can pose a hardship.
- If you don’t want the house, you will lose your option money. This might total several thousand dollars.
- If you do want the house, but your lease option contract specifies bank financing and no bank will work with you at the end of the rental period, you will be unable to buy the house. This can be heartbreaking — you may have grown to really love that house while you were living in it.
- In the situation above, you will also lose your option payment. It won’t matter that you would like to exercise your option. If you can’t exercise it, for whatever reason, you will lose all the money you have paid in for the option.
Specifics about a Lease Option with Owner Financing
In this case, the lease option contract will also contain all clauses and language relating to the final purchase of the house, should the tenant choose to exercise his option. This means that negotiating the lease option contract will be a complex and possibly very lengthy process.
Items that must be spelled out in advance include:
- Monthly rent, due date, and late penalties.
- What happens to the option if rent is not paid in a timely, consistent manner. After all, if you can’t pay your rent on time, the owner probably won’t want to do business with you for the life of a house purchase contract.
- Total price for the option.
- How the option will be paid to the owner (all in advance, or in monthly installments?)
- How the option will be applied to the house purchase, should it occur. In most cases the option is applied toward the down payment required.
- What happens to the option money if the tenant cancels the purchase. (Usually 100% of it is retained by the owner, but that’s negotiable)
- The total purchase price of the house.
- The amount of down payment that will be required in addition to any option money being applied.
- The interest rate attached to the outstanding balance of the loan.
- The amortization schedule for the loan.
- Payment due dates and late penalty fees.
- Whether arbitration must be used in case of any disputes.
If you are considering a lease option with owner financing, read the owner financing section of this guide again, since everything stated there applies equally well to this situation.
Buy a House with Lease Option with Conventional Financing
In this case the lease option contract will be simpler. It will specify most of what is listed above, but the actual terms of the loan will be up to the bank.
The lease option contract will need to state that you will get a bank loan when your rental period is over, and it will need to be specific about what window of time you have to arrange that without losing your option to purchase.
This will be an important point for the owner, because he probably won’t want to wait around for six months or a year while you arrange a loan. On the other hand, banks move very slowly, so you want to make sure you give yourself enough time to finalize your loan so that you can achieve the American dream: owning your own home . . . even after having had problems with bad credit.
Buy a House with a Cosigner
A cosigner is someone who agrees to sign for your debt; in the event that you cannot pay, the cosigner assumes all responsibility.
It may be possible to get a mortgage if you have a cosigner to cosigner for the mortgage. Keep in mind (unless terms have changed since this article — always a possibility!) that the way mortgage lenders evaluate a mortgage application by two people (which is the case if you have a cosigner) is that they look at the individual with the lowest credit history and use that as as the determining FICO score. So if you have bad credit and the other party (the cosigner) has good credit, you still won’t be able to get a mortgage.
However, IF one party has NO credit history and the other party (the cosigner) has good credit, then the mortgage lender might use the cosigner’s credit history. So a cosigner mortgage is an option if you want to know how to buy a house with NO credit history. It’s always good that you talk directly to some mortgage lenders and pose the question to them directly, however.
Buy a House through a FHA Mortgage
The FHA mortgage is a government backed home loan. What’s unique about the FHA is that it is one of the only home loans where credit history is not the most important element. You can qualify for a FHA mortgage with lower credit history than other mortgages. Now credit history still is important.The FHA mortgage website recommends you have a credit score of 580 or more to be considered for an FHA mortgage loan. 580 would be considered “average” to “bad” credit. However, it is possible to still get a FHA mortgage loan with bad credit (credit score lower than 580).
There are two cases:
Case 1: You have a FICO score of 500 or more
If this is the case, you are eligible for FHA loan financing.
Case 2: You have a FICO score of less than 500
FHA does make allowances for applicants with non traditional credit history (remember this?). If you have insufficient credit but meet all other FHA requirements, then it’s still possible to qualify for a FHA home loan through your non traditional credit history.