How Bad Credit Impacts Buying a Home
Published August 7, 2020
People with credit scores considered "poor" or "bad" may be discouraged from buying a home. Bad credit will change some aspects of your home purchase, but it's not the end of your homeownership dreams. The good news is some lenders and mortgage programs are willing to work with prospective buyers with lower credit scores.
Understanding credit scores and home financing
Lenders do significantly weigh an applicant's FICO credit score when determining if someone is qualified for a home mortgage. A FICO score is generated by the Fair Isaac Corporation to judge the likelihood someone is willing and able to repay their debts.
FICO scores range from 300 to 850, with the latter considered a perfect score. Most lenders call a score of 740 or higher "excellent" or top-rated. Experian, one of the three main credit bureaus, considers a "fair" score to be between 580 and 669 while a "poor" score is anything under 579.
Lenders use the numbers to determine how much money a person can borrow, how much time they have to repay, and their interest rate. The various mortgage programs have minimum credit score requirements. For example, our FHA home loan has a minimum credit score of 620. It will consider applicants with credit scores between 500 and 619, but there are additional restrictions and requirements.
What's the difference between bad and good credit when buying?
It's possible to have a credit score fall in the "fair" or "poor" category and qualify for a home loan. Do be aware a bad credit scores changes your financing in these ways:
#1- Loan Qualifications
You're more likely to qualify for a mortgage with bad credit if you can provide a higher down payment. This tells the lender you are willing to accept more risk and are less willing to walk away from the property. Some lenders will not consider poor credit scores without a significant down payment, such as 20 percent of the home's value.
#2- Higher Interest Rate
Lenders see bad credit as a higher risk. To offset that risk, they charge a higher interest rate. While this might amount to a small month-to-month increase compared to the best available rate, over the long-term life of the loan, it can cost thousands more.
For example, using the Mortgage Loan Calculator on Big Life Home Loan Group's website, let's say you are borrowing $160,000 at an estimated Annual Percentage Rate (APR) of 3.8 percent for a repayment term of 30 years with $0 down. The total interest paid over the life of a 30-year loan is $108,392. With a higher APR, such as 4.2 percent, you'll pay $121,673, or $13,281 more over the loan's life. *
* Figures shown are for illustrative purposes only. Contact your Loan Officer for specific guidance. Interest rates and APRs based on 8/4/2020 calculation.
#3- Finding a Lender
The lower your credit score, the harder it will be to find a mortgage program and lender willing to take the risk and extend home financing.
Improving your credit score
The three credit reporting bureaus are required to provide you with one free credit report each year. First, check your score for accuracy. A reporting error could be the cause of your poor credit score.
Boosting a credit score takes time and work, but it can be done. The reward is you'll pay less interest over time as a result of your efforts to change your score. Even a few basis points can translate to thousands in long-term savings.
The best way to improve your credit score is to reduce your debt. Pay off or pay down your balances as best as possible. Pay all your bills on time. Create a positive payment history, if you don't already have one. Understand it will take months for these changes to start impacting your credit score. This is a long-term strategy, but with the side benefit of putting you in a better financial position.
Finding loans for bad credit scores
It is possible to find a lender who will work with buyers with "fair" or "poor" credit scores. Shop around and talk to different lenders in your area. We recommend Texas home buyers use special programs for first-time and entry-level buyers like FHA mortgages. You may qualify for VA financing, USDA mortgages, a Fannie Mae HomeReady mortgage, or a Freddie Mac Home Possible mortgage.
Another benefit of speaking with mortgage lenders is you might qualify for down payment assistance. There are thousands of programs available to offset down payment costs using grants and credits, depending on your personal situation.
Speak with a mortgage lender
We are happy to talk with anyone who wants to know if their credit score qualifies them for a home loan. There are many ways to qualify for a mortgage, so schedule your call with us today!
For educational purposes only. Please contact your qualified professional for specific guidance. Not a commitment to lend. Borrower must meet qualification criteria.