Home prices are up, inventory is down, and mortgage loan interest rates are the highest they’ve been in some 20 years. Still, for consumers who would rather own than rent, it’s still possible to buy a home even with these hurdles.
And as an added obstacle for those with bad credit, your credit reports and credit scores are still front-and-center to the home-buying process. But even if you have bad credit, buying a home is still a possibility.
What Does it Mean to Have Bad Credit?
Articles that purport to accurately categorize credit scores into different tiers, such as good, bad, fair, excellent, etc., abound. The challenge with these simple credit score categorizations is getting them right.
There are thousands of financial services companies in the United States, and they don’t all hold the same definition of what are good, bad, fair, and excellent credit reports or scores. Lender A may think your FICO score of 680 is good enough, while Lender B may decline your application outright.
I’ve always taken the position that any credit report and credit score that doesn’t get you the best deal a lender has to offer can never be categorized as excellent credit. What that means is you’ll have to earn and maintain FICO scores well into the high 700s to guarantee you receive the best deals lenders have to offer, assuming you also have sufficient income and collateral.
Because we’re focusing on buying a home with bad credit, let’s focus on mortgage interest rates by FICO scores. That’s the most appropriate method because most mortgages in the United States are underwritten using three credit reports and three FICO scores, per applicant.
As of late October 2023, the published average Annual Percentage Rates or “APRs” for a garden variety 30-year fixed rate mortgage loan ranged from 7.674% to 9.263%, according to FICO.
A few years ago, applicants with FICO scores almost 100 points below the national average of 716 were getting mortgage loan APRs close to 6%. But not any longer, as we’re living in a new normal for elevated costs of mortgage loans. Today with great credit reports yielding elite FICO scores of 760 to 850, the best you’re going to do is about 7.7%.
Your options become more expensive with “bad” credit, generally defined as credit reports that have negative information that also yield lower scores. At 620, the lowest FICO score where there are actual published interest rates, you’re going to pay 9.263% for your mortgage loan.
When you apply that APR to a mortgage loan of several hundred thousand dollars, you can see how much more expensive your house just became. For example, a $500,000 mortgage loan will cost someone with FICO scores above 760 over $200,000 less than the same loan would cost someone with FICO scores between 620-639.
It certainly pays to have great credit, and it’s certainly expensive to have bad credit.
3 Best Options For Buying a House With Bad Credit
Just because you have bad credit doesn’t mean you should sit on the sidelines and rent in perpetuity. There are measurable and immeasurable benefits to homeownership, such as tax write-offs and privacy.
Accordingly, consider one of these three strategies to buy a home if you’ve got bad credit.
1. Buy Now, Refi Later
If you’ve never purchased a home, you may not be familiar with the practice of refinancing. You can apply for a mortgage loan and buy a house now. Then you can hope the APRs start going down and then refinance your mortgage loan. You’re essentially replacing your existing, more expensive, mortgage loan with a new, less expensive, mortgage loan.
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You don’t have to move out during the refinance process, and you’ll reduce your monthly payment and the amount of interest you’ll pay on your mortgage loan.
This assumes, of course, that APRs do eventually stop going up and start coming down. It’s not usually a good idea to refinance into a more expensive APR unless you’re converting an adjustable APR (one that goes up automatically over time) to a fixed APR (one that stays the same for the life of the loan).
2. Improve Your Credit, Then Buy
Just because you have bad credit today doesn’t mean you have to have bad credit forever. Credit scoring systems are actually very forgiving as long as consumers stop missing payments and polluting their credit reports with recent derogatory information.
It’s not inconceivable that within 12-24 months, someone who once had really bad credit, to the point they’re being repeatedly denied loan products, can improve their scores enough that they can easily qualify for a mortgage loan.
This strategy may work for someone who is either close enough to the mortgage’s minimum score requirement that it will only take a modest improvement to their scores, or for someone who has scores that are high enough to qualify, but who wants to improve their scores to get a lower APR — the latter being a combination of the Buy Now, Refi Later strategy with the Improve Your Credit strategy.
3. Reset Your Target Home and Expectations
In addition to just being able to qualify for a mortgage loan with bad credit scores, affordability is also a hurdle. Just because your credit is good enough to qualify for a loan doesn’t mean you’re going to be approved for a loan.
Mortgage lenders want more than just acceptable credit scores. They also want acceptable income and debt-to-income ratios. In short, you’ll have to be able to afford your mortgage payment to qualify, regardless of your credit reports and credit scores.
Other than the tired and overused “make more money” advice, which is easier said than done, prospective buyers have many options available to help reduce the cost of a mortgage loan. But instead of targeting that seven-figure McMansion in the fancy part of town, you’re going to have to reset your expectations and the price of the home you are considering.
Take into consideration buying a smaller house, a house on a smaller lot, an older house, a fixer-upper, a house in a less attractive neighborhood, or a house that is in a more rural area complete with a longer commute. These are all, generally, reasons why the price of a house would be lower than the price of a larger house or a house in a part of your city that’s in high demand.
But, the benefit to you is that a lower price equals more affordable housing options and more money in your pocket at the end of the month.
We May Never See Rates Below 4% Again
If you’re waiting for mortgage loan interest rates to hit 2.7% again like they were in late 2020 before you buy a home, you may be waiting forever. Even with bad credit, the rates in late 2020 were less than 4%. We are unlikely to see rates that low for many years, if ever again.
The new normal for the foreseeable future is mortgage APRs between 7% and 10%. We can get and stay upset about it, or we can reset our expectations and do something about qualifying for the best deal that’s currently available, even with bad credit.
That means buying now and keeping your eyes on APR movement and refinancing when it makes sense (and doing it again and again if the rates keep going down). It also means continuing to improve your credit and then buying, or simply resetting your target home and location to one that is considerably less expensive and much more affordable.