Great credit allows people to get the best interest rates on various types of loans. Bad credit is usually the result of late bill payments, bankruptcy, foreclosure and loan defaults. Rebuilding your credit score can be a time-consuming affair and just because you have bad credit doesn’t mean you can’t buy a home. In this article, we review 3 alternative financing options for the home buyer that has bad credit.
What is a Bad Credit Score?
Experian considers anything below 500 to be “very poor,” where a score above 700 is generally considered “good.” As such, if your credit score is below 500 you should probably work on rebuilding your credit score first, because even with alternative lending options this score may be too low to finance a home.
Most lenders set their own requirements, so even with a bad credit score, there are various lenders who will fund your mortgage. If you’ve exercised all traditional mortgage routes, you might want to consider these 3 alternatives.
FHA Loan
The FHA Loan program was created to help low to moderate-income homebuyers, particularly those that do not have enough cash saved for a down payment. These loans are backed by the Federal Housing Administration and only require a minimum credit score of 500.
However, with a credit score of 580, borrowers are only required to put down 3.5% of the purchase price. With a score between 500 and 579, the down payment requirement is raised to 10% of the purchase price.
Keep in mind the following:
- The home being purchased must be used as the buyers primary residence.
- Borrowers must be able to show proof of employment and a steady income.
- FHA loans can also be obtained by people who have a bankruptcy or foreclosure on their record.
- Borrowers that qualify are also required to purchase mortgage insurance.
Though it’s called an FHA loan, the FHA (Federal Housing Association) doesn’t actually fund the loan. Instead, they guarantee the loan by approving and insuring banks and lending institutions. With FHA backing, these loans are more attractive to banks as they come with less risk than a traditional mortgage.
VA Loan
VA loans are for veterans, service members, military spouses and other people associated with the military. These loans are backed by the Department of Veterans Affairs and like an FHA loan the Department of Veterans Affairs does not actually fund the loan.
They simply guarantee the loan by approving and ensuring banks and financial institutions. VA loans generally have the lowest interest rates on the market and do not require monthly mortgage insurance (unlike an FHA loan).
Keep in mind the following:
- It’s possible to get a VA loan without a down payment.
- Lenders will require a minimum FICO score of 580.
- Higher debt-to-income ratios are allowed for VA loans compared to conventional loans.
- You will pay a VA funding fee when the deal closes.
- You can check if you’re eligible on the government’s website.
There are some drawback to VA loans.
Specifically, these loans have lots of red tape, appraisal delays and are only intended to be used for the purchase of a primary residence.
Private or Hard Money Loan
If you have an existing asset worth a substantial amount of money, a private money lender (aka, hard money lender), might be your best option. These 2 loan types are very similar but have slight differences.
If you want to learn more about the differences, check out Hard Money Loans Vs Private Money Loans.
These loans come with higher interest rates and shorter terms than traditional mortgages and are generally used as “bridge loans.”
A bridge loan is a loan designed to fill a specific timeline until a property is sold or the loan can be refinanced into a cheaper alternative.
Because of this, lenders will want to understand a borrowers’ investment and exit strategy for the loan.
Keep in mind the following:
- Real estate is the most common form of collateral.
- Hard money loans can be funded in a matter of days.
- The loan application process is simpler compared to a traditional bank.
- Credit score is not the main determining factor for loan approval, the value of the underlying asset is.
- Most lenders will allow borrowers around a 70% loan to value ratio of the collateral asset.
If you know your credit rating is going to go up over the next few years but you want to purchase a home now, this could be a good option to use while waiting to refinance.
In Conclusion
Just because you have sub-par credit, doesn’t mean you have zero options when it comes to financing the purchase of a property.
