Homeownership is part of the American dream, but buying a house can be incredibly expensive. According to Zillow, the median home in the United States costs just under $250,000. In certain markets, you could be paying twice as much as that for the average home.
Few people can pay cash for such a large purchase, so most homebuyers get a mortgage to help them buy a house. However, you usually need to have good credit if you want to borrow money. If you have poor credit, buying a house can be more difficult, but it’s still possible.
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How credit affects your ability to buy a house
Your credit score affects a few things when it comes to applying for any loan, including mortgages.
The most obvious thing credit scores influence is your ability to qualify for a loan. If you have very bad credit, many lenders will refuse to offer a loan at all, for fear you won’t repay the loan. Secured loans, like mortgages, are less risky for lenders because they can foreclose on the home, but they’re still risky.
Your credit score also influences the interest rate of your loans. People who have worse credit will have to pay higher interest rates to compensate for the additional risk the lender is taking. Higher interest rates mean higher monthly payments and a higher total cost for the loan.
What to do before buying a house
Before you start shopping around for a home, there are a few things that you should do.
Check your credit
Keeping an eye on your credit is important for everyone but it’s especially important for people who are about to apply for a big loan like a mortgage. You should check your credit to get an idea of what your credit score is and the types of loans for which you may qualify.
There are many ways for people to check their credit easily, beginning withAnnualCreditReport.com. This is a website authorized by the government to give people access to their credit reports for free. You can use the instructions on the site to request a copy of your report from each of the three credit bureaus once per year.
If you want to check your credit more frequently, other services, like myFICO, can give you regular updates on your credit report and credit score. Many of these services also offer recommendations for lenders that work with people with your credit profile, or steps you can take to improve your credit.
One of the easiest ways to improve your credit is to look for errors in your credit report. Credit bureaus aren’t perfect and mistakes are more common than you may expect.
If you notice a problem on your credit report, such as an account that belongs to someone else or a payment that was marked as late even though you submitted it on time, you should dispute that error.
Each credit bureau has a different process for disputing errors, so check the credit bureaus website for the steps you should take. Removing these mistakes can give your score a significant boost, especially if you’re removing missed or late payments or delinquent accounts from your credit history.
Boost your credit as much as possible
Your credit score shows your history of interacting with credit and debt. The best way to build a good credit score is to have a long history of timely payments and managing your credit well, but that doesn’t mean there aren’t a few things you can do in the short term to give your credit a boost.
The best way to boost your score in the short term is to pay down any debt that you have. The more you can reduce your balance, the more it will help your credit score.
Another thing to keep in mind is that applying for new loans and credit cards will drop your score by a few points as credit inquiries have such an effect. If you’re planning to apply for an important loan like a mortgage, avoid applying for other loans in the months leading up to your mortgage application.
There are some tools, like Experian Boost, that help increase or find ways to improve your score. Any edge you can get is worth taking because even a small difference in your credit score can influence your loan’s interest rate.
How to buy a house with bad credit
There are a few things that you can do if you’re trying to buy a house with bad credit.
Accept a higher rate of interest
The reality for people with less than perfect credit is that they’ll have to accept higher interest rates on the loans they qualify for. If you go into the mortgage process knowing that you won’t get the best-advertised interest rates, it can make it easier to accept the higher rates you’re offered.
If you want to buy a house now, paying a higher rate of interest is part of the cost. If you can't handle the higher rates, you may want to wait while you work to boost your credit score.
Apply for an FHA Loan
The Federal Housing Administration (FHA) insures some loans for people with poor credit. That makes FHA loans much easier to qualify for than traditional mortgages. Another perk is that FHA loans only require a down payment of 3.5% of the home’s value instead of the 10% minimum.
The cost of an FHA loan is that you’ll have to pay for mortgage insurance. This is an additional cost tacked on to your monthly payment and ranges from .45 to 1.05% of your loan’s balance.
Unlike private mortgage insurance (PMI) which applies to conventional mortgages, you can’t get out of paying mortgage insurance on FHA loans, even once you build equity in your home. The only way to stop making these extra payments is to refinance the mortgage.
Make a large down payment
Lenders’ primary concern when making loans is whether the borrower will repay the money that they borrow. If the borrower defaults, the lender loses the money it lent and has to try to recover it by foreclosing on the home.
To reduce the lender’s risk and increase your chances of qualifying for a loan, you can try offering more than the typical down payment on the home. This reduces the potential loss for the lender and shows that you are willing to put more of your own money on the line.
The more you put into the home, the less likely a lender is to think that you’ll be willing to walk away from the loan. This can help you qualify for mortgages you’d otherwise be unable to get or secure lower interest rates.
Buying a house can be difficult, especially if you have less than perfect credit. Still, it’s possible to get a mortgage with poor credit as long as you take the time to prepare and are willing to show lenders that you’re taking the purchase seriously.