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Buying a home is both exciting and overwhelming. It can also be rather stressful if you worry about your bad credit. The good news is buying a house with bad credit is not an impossibility. However, to improve your chances of getting a loan you should follow certain steps. Doing so will make the entire process a little easier and less stressful.
The first thing you want to do is get a copy of your credit report. You can request a free copy once a year from each of the three major credit reporting bureaus: Equifax, TransUnion, and Experian. You can also use various credit report services to get a copy as well. Just know that some might charge a fee or require you to sign up for other services.
You’ll want a copy of your credit report because you will need to know exactly how bad your credit is. The numbers provided from each bureau will vary slightly, but they should all be within a certain range. Viewing your credit report doesn’t just tell you your credit score. It also tells you why your credit score is what it is. For example, maybe you have too much debt, or maybe you’ve had some late payments reported.
Fixing some of these negative marks can quickly improve your credit score. Paying off debt, for example, will make a big difference in your debt to income ratio. This not only improves your credit score but also looks good to lenders.
Other things might not be so easy to fix quickly. Late payments stay on your credit report for a while. So do more severe notices such as filing for bankruptcy, which will stay on your credit report for seven years.
But you might also find errors on your credit reports, such as a collections notice or a late payment that never actually occurred. Follow the instructions provided on the credit bureau’s web page to dispute the error. If they indeed found it to be erroneous, they will remove it from your credit report.
That really all depends on the lender. Different lenders will have different guidelines. Some might look past a low credit score if you can provide valid reasons for the poor score. For example, maybe a prior layoff from a job or a divorce several years ago resulted in financial problems for a while.
As an unwritten rule, you’ll want to have a credit score in the good range, which is 670-739, or above. Anything below that and may be more difficult to get approved. Additionally, if you are approved for a mortgage, you may pay a higher interest rate.
Being qualified for a loan is one thing. Being able to pay the monthly mortgage and the closing costs on a home purchase is another. Lenders will also be looking at your finances to see if you have enough to make your down payment, pay closing costs, and make your monthly mortgage premiums. If you are buying a house with bad credit, you will probably have a higher interest rate on your mortgage. This could make your monthly premiums higher than you thought they’d be.
One of the most important things you can do before seeking a mortgage is to pay off any debts you have. Lenders will look carefully at your debt to income ratio. Some might even consider it more important than your credit score. Your monthly debt payments will also be more of an issue if you have a higher mortgage premium because of higher interest rates. Getting rid of your debt not only makes you more favorable to a lender but also improves your credit score and ensures you have more money available each month to pay your premiums.
When buying a home with bad credit, you also want to take time to figure out your budget. If you can’t pay off all your debts right away, you’ll need to see exactly how much income you’ll have left over to pay a mortgage premium. This will give you a good idea of how much house you can afford and save you the trouble of looking at houses beyond your price range.
A standard rule of thumb when seeking a mortgage is that the yearly payments should be no more than 28% of your yearly gross income. But be sure to consider all your other expenses besides your debt, such as groceries, household expenses, gas, etc. You might realize that you’ll need to find a home that costs less than you originally thought you could afford.
Besides conventional loans, there are other loans to choose from. Some might be more suited to your financial situation. For example, if you aren’t able to save enough for a down payment, an FHA loan might be more workable. When buying a house with bad credit, FHA loans are also a good option since their minimum credit score requirement is around 580. If you can make a 10% down payment, they might approve you for an FHA loan with an even lower credit score.
Of course, improving your credit as much as possible before buying a house will also make a tremendous difference. Not only will you improve your chances of getting a loan, but you’ll also be eligible for lower interest rates. If you aren’t looking to buy a house so soon, start trying to improve your credit first. Pay down your debts and save up money for a down payment if possible. Remember the path to homeownership isn’t always easy even for people with good credit. But with hard work, the right information, and by following the steps above, you can make your own journey a little easier.