Have you put off buying a home because you don’t have good credit? Did you know there are programs for first time buyers with bad credit? It might take a little more work and creativity, but there are loans available. Understanding your options can help you find the loan that works for you, putting an end to your days of renting.
FHA Loans for First Time Buyers
The first avenue to exhaust is the FHA loan. This used to be the main first time homebuyers loan. Most other borrowers didn’t even bother with the program. Today, it is a great program for any borrower, but especially for those with bad credit.
The FHA loan doesn’t require great credit. In fact, you can get a loan with a credit score as low as 500 if you wanted. The difference is you’d have to put 10% down on the home rather than 3.5%. But, you’d get the loan you need.
As long as you have a credit score higher than 580, you can put as little as 3.5% down on the home. The FHA also has other flexible guidelines, making approval easier.
- Your housing payment can take up as much as 31% of your gross monthly income
- Your total monthly payments can take up as much as 43% of your gross monthly income
- You can be self-employed
- You can have a new job as long as you have proof of your new income
The FHA offers a lot of flexibility than a conventional loan doesn’t allow. Because the FHA guarantees these loans, lenders are willing to take the risk. They know they will receive money back from the FHA if you default on your loan.
If you are a veteran, don’t overlook the benefit of the VA loan. This is another government-backed loan with flexible guidelines. The VA doesn’t have a required minimum credit score. But, most lenders prefer a score of at least 620.
With the VA loan, you don’t have to put any money down. You can secure 100% financing, which is great for veterans just starting out. Because you don’t need a lot of money upfront and you don’t need great credit, it lets veterans start their life out as homeowners. The largest requirement is that you can prove you can afford the payments.
The VA doesn’t have a maximum debt ratio, but no borrower can have a ratio higher than 43% for any investor-bought loans. The VA puts greater emphasis on the disposable income you have each month. They believe this helps reduce the risk of default on a mortgage.
If you are a veteran with at least 180 days served during peacetime or 90 days during wartime, it’s well worth looking into this program.
Subprime Lenders for First Time Buyers
If you have bad credit, you probably won’t secure conventional financing. If you don’t want to go the government route because you aren’t a veteran and don’t want to pay mortgage insurance on the FHA loan, consider subprime loans.
These loans, while the name sounds bad, are just as good as any other loan. You aren’t going to pay overwhelmingly large fees or interest rates as long as you shop around. The sneaky lender that charges crazy high fees and rates may still exist, but they are definitely fewer and further between today.
Subprime loans are simply loans lenders keep on their books. They don’t sell them to the secondary market, namely Fannie Mae and Freddie Mac. In other words, the banks make up their own rules. They fund the loans and service them. They have a say in what goes.
It helps if you have a decent income and assets on hand. This helps the lender know that you are a good risk despite your bad credit. The more money you can put down on the home, the better your chances of approval. Lenders aren’t likely to provide you with a high LTV loan if they are taking all of the risk.
Create Compensating Factors
Whether you apply for the FHA, VA, or subprime loan, you’ll need one thing if you have bad credit – compensating factors. These are things that “make up” for your bad credit. They help balance out your financial mistakes. A few good compensating factors include:
- Reserves – After you make your down payment, lenders like to see that you didn’t wipe your savings out. If you have money left in a liquid account, it serves as your backup to make your mortgage payments. The lender counts these reserves based on how many mortgage payments it covers. On a $1,500 mortgage payment, $3,000 would cover 2 months. The more reserves you have, the better your chances of approval.
- Stable employment – No one says you have to be at the same job for 2 years anymore, but it helps. Stability shows the lender you are consistent. If you have had three jobs in the last year, you pose a higher risk than someone that had the same job for 5 years. There’s nothing reassuring the lender that you’ll remain employed and be able to afford your mortgage if you job hop.
- High down payment – Speaking of money, the more money you put down on the home, the better your chances of approval. Lenders want to loan you as little as possible while still making money. They calculate your loan-to-value ratio. The higher it is, the more risk you pose. A good rule is to borrow less than 80% of the home’s value if you can.
Work on Your Credit
Of course, you can always work on your credit score too. If you can’t find a loan for a first time buyer with bad credit, go straight to the source. Figure out what is wrong with your credit and fix it. For example, do you have a lot of late payments? Bring them all current and keep up the habit.
If you have too much credit outstanding, start paying your bills down. If you have too many inquiries recently, wait at least 6 months until they aren’t as new and watch your credit score increase.
There are ways you can get a loan as a first time buyer with bad credit – you just have to work for it. Make sure you shop around with different lenders. See what each of them has to offer. Compare the rates, fees, and the APR. This way you can choose the loan that works best for you now and in the long run.