How to Buy a House with Bad Credit

How to Buy a House with Bad Credit
Steven Tumulski
By: Steven Tumulski
Posted: May 24, 2013's popular "How-To" series is for those who seek to improve, rebuild or better understand their subprime credit rating.

Home ownership is the American dream. However, as we’ve recently covered, about one-third of Americans won’t qualify for a mortgage because of their low credit.

If you find yourself in this situation, you have only two options:

1. Buy your house with cash.

2. Improve your credit rating until you qualify for a mortgage.

Obviously, with real estate prices at close to their all-time high, it’s virtually impossible to save up enough cash for an outright purchase.

Follow this guide to improve your credit score until you can fulfill the American dream.

1. Check your credit score.

Before doing anything else, you need to figure out exactly where you currently stand.

The easiest way to do this is by pulling your credit report from the three major credit bureaus — Experian, Equifax and TransUnion. You can do so for free once per year by visiting

If your score is lower than 580, you won’t be approved for any mortgage.

Score between 580 and 619 and you’ll be approved for mortgages with high interest rates and prepayment penalties — both of which are undesirable.

Those scoring between 620 and 680 will qualify for mortgages with far fairer terms. Those at 681 and above should qualify for average mortgages with average rates.

2. Maintain steady employment and earnings.

When you apply for a mortgage, the lender is hoping to see a few things. One of these is steady employment with consistent earnings.

Before applying for a mortgage, it’s wise to stick with the same employer for one to two years. It’s also important you demonstrate regular, predictable hours.

3. Take the appropriate steps to improve your credit score.

If your score is below 580, you’ll have to take a few steps to boost your score. If it is higher, you may still want to put these steps to use.

Improving your score will help you attain a loan with a lower interest rate, which can save you tens of thousands of dollars or more over the course of your mortgage.

These steps include:

  1. Taking out a secured loan or secured credit card and making your payments on time
  2. Paying down existing credit card and loan balances to improve your debt-to-credit ratio
  3. Opening an additional line of revolving credit to improve your debt-to-credit ratio
  4. Opening an auto loan and paying consistently

“Before doing anything else, you need to figure

out exactly where you currently stand.”

4. Monitor your credit score.

If you’re not hoping to qualify for a mortgage within the next year, you’ll be able to check your score again with

If you’re hoping to improve your score and qualify for a mortgage sooner than that, consider a service that monitors your credit, such as those offered by Equifax.

Equifax provides a credit score simulator with many of their paid membership services, helping you on your quest to improve your credit score.

You can receive recommendations on what actions to take to boost your score or choose detailed actions and see what impact they will have.

5. Try for Prequalification.

Prequalification is not the same as preapproval. With prequalification, you’re simply asking the bank to provide their likely decision, were you to apply for a mortgage of a specific amount.

Prequalification is fairly accurate but shouldn’t be seen as a guarantee of approval.

Instead, it will help you understand how much money you’ll need to save as a down payment, what interest rates you might qualify for and the size of the mortgage you’re likely to be approved for.

6. Save for an appropriate down payment.

Now that you know how much money you’ll need down, you should start saving toward it.

With most FHA loans, you’ll need at least 3.5 percent down (or $1,250 for every $50,000 borrowed). Don’t forget to factor in closing costs and other fees, which typically range from 2 percent to 3.5 percent as well.

If you can save even more, then it will improve your chances of receiving a mortgage. Saving at least 20 percent down will virtually guarantee an approval and a lower monthly payment, as private mortgage insurance won’t be required.

7. Find a realtor and home you love.

You can start working with a realtor at virtually any point in the process, but it’s usually wise to wait until you have everything sorted out with your credit situation.

By this point in the process, you should have a substantial down payment saved up, know your credit score and have a letter of prequalification in hand.

All of these things will help your realtor find the perfect home for your family. Since everything is already lined up, you’ll be able to move quickly once you find it.

8. Make your payments on time and keep an eye on refinancing.

As long as you continue to make your payments on time, your credit score will continue to improve.

Eventually you’ll be in a position to refinance your mortgage and receive a lower interest rate. This is even more important if your current mortgage includes PMI payments.

While not absolutely required, it’s smart to wait to refinance until you’ve established 20 percent equity in your home.

You can do this by making a large payment toward your principal, but you may also find the value of your home has increased enough to put you in the same position.

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