5 Steps to Get a Loan as a First-Time Home Buyer (With Bad Credit)

First Time Home Buyer Bad Credit

Some things in life can be both exciting and terrifying, all at the same time. Buying your first home, for example, is certainly exciting — but that six-figure debt most decidedly is not exciting; at least, not in a good way.

And, unfortunately, when you’re trying to buy your first home while also dealing with bad credit, the exciting-terrifying scale can start to tip all the more toward the “terrifying” end of the spectrum. But if you’re a first-time home buyer with bad credit, don’t lose hope because your past financial missteps will not necessarily derail your desires to purchase a place of your very own.

Thankfully, there are a few things you can do to help keep the home buying process a pleasant one, even with bad credit. Options exist that can help first-time home buyers boost their credit scores, find a lender, and even save up a good down payment.

1. Clean Up Your Credit Report

Although a low credit score won’t necessarily bar you from becoming a homeowner, the higher you can get your credit score before you start shopping for a home, the better your chances of finding (affordable) funding will be.

Cleaning up your credit report can also have positive credit score impacts, particularly if you can have negative items removed through credit repair. While this can be done yourself, an experienced credit repair company can speed the process.

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Credit repair — either DIY or with a professional — is the process of disputing erroneous, outdated, or unsubstantiated items that appear on your credit report and drag down your score. However, keep in mind that legitimate debts and negative items can’t be removed.

Additionally, paying down existing debt can be one of the quickest ways to boost your credit score, especially if you have high debt-to-income and/or utilization ratios. Paying down any credit card balances near their limits, for example, can lower your utilization rate and improve your credit score.

In some cases, the best thing you can do to ensure you have a clean credit report before buying a house is simply to wait. Most negative items can only stay on your credit report for up to seven years, and the impact that negative items have on your credit score will naturally diminish as they age.

2. Look for First-Time Home Buyer Programs

There are a lot of benefits to having experience when buying a home, such as the confidence of knowing the steps you need to take and a better understanding of the myriad fees you’ll face.

That being said, being a first-time home buyer does have one thing going for it: first-time home buyer programs.

To encourage first-timers to enter the real estate market, various governments offer programs, loans, tax incentives, and grants aimed at helping first-time buyers to, well, buy.

National First-Time Home Buyer Programs

Although there are a few national programs backed by the federal government that help home buyers, first-time home buyer programs are actually operated primarily at the state, county, and/or city level.

The federal government does not give housing grants directly to individuals. The funds are given to states and certain municipalities, who in turn, distribute the funds to residents. — HUD

The programs that are available at the national level are actually open to all eligible buyers, regardless of whether they’ve purchased a home in the past. These programs are mostly special loans partially insured by a federal department, though there are a few other programs and incentives available.

  • Federal Housing Administration (FHA) Insured Loans: Mortgage loans insured by the FHA that allows a smaller down payment and lower credit score than conventional mortgages.
  • Veterans Affairs (VA) Insured Loans: Mortgage loans insured by the VA, available to active and retired military members, that allow for low to no down payment and have flexible credit requirements.
  • US Department of Agriculture (USDA) Insured Loan: Mortgage loans insured by the USDA that require no to low down payments and have flexible credit score requirements. Can only be used to purchase eligible rural properties.
  • Good Neighbor Next Door Program: A US Department of Housing and Urban Development (HUD) program that offers a 50% discount on the list price of a home for law enforcement officers, pre-K through grade 12 teachers, firefighters, and EMTs. The property must be your sole residence for 36 months after purchasing.
  • Various Tax Benefits: A number of tax credits and deductions are available to homeowners, including home mortgage interest deductions, mortgage points deductions, and property tax deductions.

Each program/incentive for home buyers will have its own specific requirements, and not all buyers will be eligible for each program. Be sure to do your research to determine the programs for which you may be eligible.

State & Local First-Time Home Buyer Programs

To find programs specifically geared toward first-time home buyers, you’ll need to research available state, county, and city programs.

The programs available in your area will vary based on a number of factors, including local housing prices and which areas are in need of revitalization.

Local first-time home buyer programs may simply offer easier-to-obtain loans, or they may provide down payment assistance, grants, and/or tax incentives. To see a list of the programs available in your area, check out HUD’s list of first-time home buyer programs by state.

As with national programs, state and local home buyer programs will each have their own specific criteria for eligibility, so do your research ahead of time. Additionally, any program that uses federal funds will come with a mandatory counseling requirement.

Any program the federal government has to assist first-time buyers in a home purchase will require that you attend a HUD-approved Housing Counseling class. They help people get their finances organized so they will qualify for a mortgage. — HUD

An important thing to watch out for when researching programs is marketing schemes that claim to be first-time home buyer programs, but are actually simply ads for real estate companies, brokers, or lenders. Make sure to double-check any potential programs before entering into any sort of financial agreement.

3. Use a Lender with Flexible Credit Requirements

When looking to purchase a house with a low credit score, finding a lender can often be the most difficult piece of the puzzle. That’s because each individual lender can set its own down payment and credit score requirements, even for many special loan programs.

The FHA, for instance, doesn’t have a minimum credit score for its mortgages, but specific lenders can — and usually do — set their own limit (typically around 620).

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On the bright side, you don’t have to worry about the potential credit score impacts of shopping around when it comes to home loans.

While you’d normally get a credit score ding from each hard credit inquiry when applying for multiple products, the credit scoring companies understand the importance of comparison shopping when it comes to major purchases like a new home.

So, when you rate shop for a mortgage, any related credit report inquiries made within the same period — between 14 and 45 days, depending on the scoring model — will only count as a single inquiry.

Additionally, for mortgage loans, the model ignores inquiries made in the 30 days prior to scoring, so as long as you find a loan within 30 days, your inquiries won’t affect your score.

4. Save as Much of a Down Payment as Possible

Although there are programs that will help you find a mortgage with both a low credit score and a low down payment, your chances of obtaining a mortgage — and of that mortgage being affordable — will increase significantly as the size of your down payment increases.

The conventional mortgage standard is to have a down payment of at least 20% of the purchase price of the home. This not only increases your approval chances, but will also eliminate the need for costly mortgage insurance fees.

With a good credit score, it’s possible to obtain a conventional mortgage with as low as a 5% down payment — but the key words here are “good credit score.” If you have a credit score below 680, the chances of qualifying for a conventional mortgage at all significantly decrease.

For FHA-insured mortgage loans, you’ll need at least a 580 FICO Score to qualify for the lowest down payment amount of 3.5%. However, as noted above, lenders have the right to set their own credit score standards, even for FHA-backed loans, so you may need to put forward a larger down payment if your score is below 620.

Table of Minimum Down Payments by Mortgage Type & Credit Score

Depending on your location and qualifications, you may qualify for down payment assistance through your state, county, or city. You can see available assistance programs by state through the National Council of State Housing Agency’s (NCSHA) list of housing finance agencies.

If you’re looking to participate in a down payment assistance program, be sure you understand the terms of the program and the type of assistance it provides.

For example, some programs simply offer you the ability to finance your down payment, effectively creating a second mortgage at the same time you open your first mortgage.

In contrast, down payment assistance grants provide what is essentially free money, offering as much as 3.5% toward your down payment that you don’t have to pay back.

5. Avoid Becoming “House Poor” By Sticking to a Budget

When shopping for your first home, it’s all too easy to get swept up in the excitement of it all — especially when trying not to think about the terrifyingly large debt you’re about to take on.

But it’s important to keep that enthusiasm from sweeping you away entirely. And that’s particularly true when it comes to setting, and sticking to, your house-buying budget.

That’s because too many first-time home buyers (and second- and third-time buyers), can wind up “house poor,” which is when you sink all of your funds into your new home — and have nothing left for, you know, living your life.

So, while it’s perfectly acceptable to be excited about buying your first home, don’t forget to be responsible, too. If you set a budget, save a reasonable down payment, clean up your credit, and do your homework, being a first-time home buyer can be a grand adventure.

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