How To Buy A Home With Bad Credit: 5 Steps To Take
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Your credit history is one of the most important factors lenders consider when deciding whether or not to approve you for a mortgage to buy a home. Potential borrowers with bad credit may find it difficult to obtain a loan, but it might be possible to be approved despite a low credit rating.
What is the minimum credit score for buying a home?
The exact credit score requirements vary by loan type and lender, but the following guidelines will give you a good idea of what to expect:
- Conventional loan: 620
- Jumbo loan: 700
- VA loan: No minimum imposed by VA, but lenders generally require a minimum score of 620
- FHA loan: 500 with 10% deposit; 580 with down payment of 3.5%
- USDA Guaranteed Loan: No USDA-imposed minimum, but lenders generally require a minimum score of 640
Good to know
Your credit score is not the only credit factor that affects your mortgage application. You will also need a recent on-time payment history. According to Gustan Cho of Gustan Cho Associates Mortgage Group, it is better to have a lower score without late payments in the past 12 months than to have a higher score with recent late payments.
How to buy a house with bad credit
You can make yourself a better credit risk in the eyes of potential lenders by putting the numbers in your favor.
1. Plan to pay at least 20% deposit
A large down payment increases your participation in homeownership and reduces the risk of default on your loan. Depositing at least 20% also allows you to avoid mortgage insurance, which protects lenders in the event of borrower default, but adds a monthly premium to your mortgage payments and costs you more at closing, according to the. Consumer Financial Protection Bureau.
2. Build up cash reserves
You’ll want to save at least two months of home payments, including principal, interest, taxes, and insurance, but some lenders require up to six months for riskier borrowers. Cash reserves include bank accounts, stocks and bonds, and funds acquired in retirement accounts and life insurance policies – money that you can withdraw quickly in the blink of an eye.
3. Reduce your debt-to-income ratio
Mortgage lenders want you to have a lower debt-to-income ratio because you’re more likely to fall behind on mortgage payments if you’re already juggling other debt. To determine your DTI ratio, add up your monthly debt payments and divide that number by your gross monthly income. The CFPB recommends a DTI ratio of 43% or less, but a ratio of 36% or less gives you the best chance of being approved for a loan.
4. Get a second job
A side concert will strengthen your mortgage application by increasing your income and reducing your DTI.
5. Reduce your loan-to-value ratio
The LTV ratio is the amount of your mortgage divided by the appraised value of the house you are buying. The lower the LTV, the less risky the loan will seem to the lender because you will have more equity in your new home. Keep your LTV low by looking for the right values and making the biggest down payment you can afford.
How to improve your credit to get a better mortgage rate
If your credit rating is low due to financial mistakes you have made in the past, your goal should be to increase it so that you can not only qualify for a loan, but also get a competitive interest rate. .
Here’s what you can do to improve your credit score:
- Check your credit report for errors: If you find any errors, contact the three credit bureaus with the appropriate documentation to correct them.
- Pay your bills on time: Paying on time is one of the best ways to improve your score.
- Pay off the debt: Paying off debt, starting with collection accounts, will lower your DTI and could increase your credit score.
The bottom line
Buying a home with bad credit can be difficult, but it is not impossible. Increase your credit by reducing your debt, cleaning up your credit report, and saving a big down payment as well as cash reserves.
Elle Martinez and Michael Galvis contributed reporting for this article.
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