About this Article:
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 we show you the best ways that you should learn about this and keep in mind:
- Buy a home with a large down payment and bad credit
- With owner financing
- Buy a house through lease option
- With lease option with conventional financing
- Buy a house with a cosigner
- Through a FHA Mortgage
But first, before you learned 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 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 (for free) or you can write a letter to all 3 major credit agencies and request your credit report to 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 American Express / Bank of America), 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.
Essential conditions buying your house:
1. 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, 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.
2. 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.
3. 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.
Could your FICO Score effect on your Mortgage?
The relationship between your FICO score (credit score) is important to understand:
- 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 – 5.780% or lower
- 700 to 759 – 6.002% or lower
- 660 to 699 – 6.286% or lower
- 620 to 659 – 7.096% or lower
- 580 to 619 – 8.583% or lower
- 500 to 579 – 9.494% or lower
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 are you looking you 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.
- 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
- With your FICO score is between 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
- You have the best interest rate possible if your FICO score is 760-850.
How to buy a home with bad credit but good income?
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.
Are you buying a property 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 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.
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.
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.
But if at the end of your rental period you decide 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.
What’s the 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 first ever living in the house.
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.
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.
Buying a Home 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 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.