Financing a home purchase under favorable conditions may not be a problem; however, for millions of potential homebuyers who have been negatively affected by the recent financial crisis, securing home financing for your dream home may be challenging. “Challenging” however, does not mean “impossible.” Just because your credit score and/or credit history is less than perfect does not mean you have to give up your dream of owning a home. Less than perfect credit simply means that you will need to be more creative, and possibly more patient, when it comes to financing a home purchase.
What Does Your Credit Score Mean?
In the United States there are three major credit bureaus that gather information about you and assign you a credit score. When it comes to home financing, your credit score is a huge factor in determining whether or not you will qualify for a loan and what your interest rate will be for your mortgage loan. Credit scores typically range from around 400 to 900. Individual lenders will decide what they consider an exceptional score, an adequate score, and a poor score; however, most lenders will not offer the best rates to anyone with a credit score below around 700-750. Scores between 600 -700 may be considered acceptable, but not good enough for the best rates while scores lower than 600 are usually considered to be in the “poor” credit category.
When it comes to home financing, a borrower with excellent credit often has the option of qualifying for a conventional loan. These lenders will typically not consider a borrower with less than a credit score of around 700 or higher. Though a conventional loan requires a higher down payment, the interest rates are usually lower than other options. There are a variety of conventional loans to choose from, so it is recommended that you meet with a lender in order to get a better idea of what type of loan is the right fit for you.
One option for a borrower with a credit score in the “acceptable” to “poor” categories is to apply for an FHA loan. Because these loans are underwritten by the Federal Housing Authority (FHA), the eligibility guidelines are a bit more flexible than those for a conventional loan. Currently, a credit score of 580 is needed to receive maximum financing. Those with a credit score in the 500-579 range may still be eligible but can only finance 90 percent of the home’s value. A score below 500 will not qualify you for financing through an FHA loan program. Along with being more forgiving with regard to your credit score, FHA loans also require much less of a down payment – 3.5 percent versus 20 percent for a conventional loan.
Like FHA loans, a VA loan is backed by the federal government – in this case the Veteran’s Administration (VA). Also like FHA loans, eligibility requirements for a VA loan are more borrower-friendly than those for a conventional loan. There is no set minimum credit score needed to qualify for a VA loan; however, most lenders want to see a score around 600 or higher. Before you get to your credit score though you must qualify as a veteran, the spouse of a veteran, or one of the other narrowly defined categories of people who qualify for a VA loan. As with an FHA loan, the down payment required for a VA loan is much less than a conventional mortgage loan – in some cases no down payment is required!
Another option that is gaining in popularity is what is called a rent-to-own option. In essence this is a legal agreement whereby the owner of the property finances the purchase, or acts as the lender, for the borrower. Financing a home purchase through the use of a rent-to-own agreement can be an excellent solution for anyone who has bad credit and needs time to resolve their credit issues in order to qualify for a mortgage loan. Though these contracts can be written with a wide variety of terms in them, the basic concept is that the borrower will have possession of the property as well as legal rights to the property while paying an agreed upon purchase price to the seller through monthly payments. Generally, State statutes or precedential cases govern rent to own agreements and it is crucial that you understand how your state views these agreements in the event of a default on the part of the home buyer/home renter. A well drafted rent-to-own agreement can provide a buyer/renter with the ability to have possession of the home while working on credit issues; however, make sure that a seller does not take advantage of your desire to own a home and include only terms that are favorable to the seller in the contract – it’s definitely recommended that you reach out to a real estate professional for more information.
Don’t let you dream of owning a home die just because your credit is less than perfect. Home financing is possible for people with bad credit—you just need to explore the options and find one that works for your situation.