If you are a first-time homebuyer, you have many options at your fingertips when it comes to home financing, even if you have low credit. Now that we are many years outside of the mortgage crisis, lenders are getting a little more lenient with their guidelines. Programs that used to require excellent credit scores of over 700 are now offering loans to people with credit scores as low as 500 in some cases. Of course, these programs are not as readily available as those programs for borrowers with excellent credit, but if you are a first-time homebuyer and have low credit, there are ways to get a loan.
Figure out your Situation
The first step is to figure out your situation. How low is your credit? Why is it low? These are the two most important questions. There is a large difference between having low credit because you made your payments late and ran your credit down and when you have a low credit score because of insufficient credit. If you have a blemished credit history, the best thing to do is to start making things better starting today. If you have insufficient credit, you will need to start getting your alternative credit paperwork ready. Here’s how to handle both situations:
Bad Credit – If you have bad credit, try to do some of the following
- Start making your payments on time, bringing all accounts current.
- Continue making your payments on time for at least one year.
- Save up as much money as you can for a down payment and/or reserves.
- Make sure your income is as stable as possible (avoid changing jobs for the next year or so if you can help it).
Insufficient Credit – If you have a “low” credit score because you do not have any credit, try to do some of the following:
- Find paperwork from any payments you make now that occur on a regular basis. This could include insurance, rent, utilities, and tuition. Canceled checks or letters from the companies you pay will suffice.
- Save as much money as you can for a down payment and/or reserves to make your situation look more promising.
- Make sure your income is stable; do not change jobs within a year or two before applying for the loan.
Once you know where you fall, you can start to make your loan profile look more enticing. Bad credit does not always mean no loan – it just might mean that you have to work a little harder during the months or years leading up to the loan application in order to obtain a mortgage.
Home Loan Options
Today, there are many loan options available for first-time homebuyers. Understanding what each program requires can help you see where you fit in the best.
- Conventional Loans – These are loans that Fannie Mae and Freddie Mac purchase. They are the most common loans on the market because they offer great terms, but they often require stricter guidelines in order to qualify for the loan. The parameters of most conventional loans include:
- At least a 3% down payment, but if your credit is too low, 5% or higher may be necessary
- Credit scores typically need to be higher than 660
- Debt ratios need to be below 43% for your total debt
- Your income must be stable
- Your employment must be stable
- You must not have any collections or judgments that are current
- FHA Loans – FHA loans have less stringent guidelines in regards to credit scores and debt ratios. Many first-time homebuyers find it easier to qualify for this program. The parameters of this loan include:
- At least a 3.5% down payment if your credit score is above 580. If it is below 580, a 10% down payment is required.
- Most lenders require credit scores of 580, but the FHA does allow scores down to 500.
- Debt ratios are usually kept under 31% on the front-end and 43% on the back-end.
- Income and employment must be stable for the last 2 years.
- All collections and judgments must be paid.
- USDA Loans – USDA loans are another mortgage product that the government guarantees. The loans are reserved for those with low to moderate income and for homes in rural areas. The parameters of this loan include:
- No down payment necessary.
- The home must be within the USDA rural boundaries.
- The credit score requirement can vary, but 640 is a good cutoff.
- You do not need a long employment history; you just need to be employed.
- Debt ratios need to be no higher than 29% up front and 41% on the back.
The answer regarding which loan is best for first-time homebuyers with bad credit is dependent on the exact circumstances. If you have compensating factors, such as long-term employment, a large down payment or 12 months’ or reserves on hand, you make up for the fact that you have bad credit. That being said, every lender and every program view “bad” credit differently, so shopping around with different lenders will help you get the best results regarding which loan is right for you.