Buying a Home with Bad Credit

Since we are going to be talking about “bad credit” we should probably put some definitions around good vs bad credit. Credit scores or what is traditionally known as FICO scores is what the mortgage lenders use as a starting point for making a determination of risk when it comes to lending money. Since there are 3 credit bureaus that report a person’s credit (Experian, Transunion and Equifax) then someone who has credit (if you’ve never used credit then you don’t actually have a credit score) will have 3 different credit scores (one from each bureau).

Mortgage lenders use the middle score (that is when ranking your 3 credit scores highest to lowest, the score in the middle) for mortgage purposes. Typically the lowest your middle credit score can be and still qualify for a mortgage is 580 though there are loan products that with a big enough down payment (typically 10% and over) that one can get approval at a much lower score such as 520. 

According to Experian, scores ranging from 580-669 are “Fair” and Scores 670 and above are good to exceptional. Below 580 is what they call “Very Poor” and for the purpose of this article, we’ll just call it “bad credit” or in the eyes of the lender “high risk”.

You may also be interested in my First Time Home-buyer’s Guide.

Most people think they have an idea of their credit scores because of apps like Credit Karma or Credit Sesame but how accurate are these applications? The actual formulas that the credit bureaus use to determine your credit score aren’t published and so the makers of these apps are using “simulated scoring” based on their own algorithms and data provided to them by Transunion and Equifax (that’s right, they have no information from Experian whatsoever!).

The big question then becomes: can I trust my score from Credit Karma or another site? The answer is yes but not really. The number they gave you is a thumb in the air and on any given day doesn’t mean a whole lot; I’ve seen these apps be off by over 150 points. What they are good at is over time showing trends. If your “credit score” over time is shown to be going up then most likely your real FICO score is going up or is about to go up and vice versa. 

To get your actual FICO score you need a lender to actually pull your credit. The simulated scores when trying to buy a home with bad credit won’t help you much.

Now that we’ve defined “bad credit” as any score under 580, the question comes up can I buy a home with bad credit? FHA loans are typically obtainable with scores under 580 if you have a down payment of at least 10% of the purchase price and typically some reserves as well. Many lenders that did these loans in the past, have temporarily paused doing them because of the 2020 pandemic COVID-19 so check with a good lender or give me a call to discuss your current situation. For those that do not have the down payment and / or reserves needed you’ll need to read on so that you can buy a home with good credit!

You may also be interested in understanding Buyer’s Closing costs.

This is a question I get almost daily; my phone rings and someone is looking for rent to own. The problem that I have with rent to own is that most of the rent to owns you find out there are scams. I’ve talked to countless people who have been scammed out of thousands and sometimes tens of thousands of dollars trying to rent to own. Some people that call me even have friends who were scammed and yet they’re still looking for one! I get it, homeownership brings a sense of pride and accomplishment and I want you to experience that but I don’t want you to fall victim to a scam!! And since most people can’t buy a home with bad credit this seems like the easier way out. 

So are there legitimate rent to own opportunities out there? Yes there are but they are honestly very few and far between and more likely than not you’re going to overpay for a rent to own home (ask yourself, why would someone sell to you rent to own when they can just sell to a qualified buyer instead?) or you’ll fall prey to one of the many scammers out there. It’s just not worth it!! It’s far better to take 3 to 6 to 9 months to fix your credit and purchase a home than take unnecessary risks trying to find a rent to own home.

You may also be interested in understanding your Rent Payment.

This is another common theme I see where people have signed up with so called credit repair companies to “fix their credit”. While this is an option, the real question is do you actually need credit repair and what will a credit repair company do?

The first thing they’ll do is put you on a monthly subscription plan to “fix your credit” for you. Prices typically range in the $100-$130 per month range and for some folks that just don’t have time to do anything it might not be a bad option.

The first thing credit repair companies do is to dispute all derogatory items on your credit report which forces the creditors to respond that the items are legitimate (if they actually are) within 30 days. What they’re hoping for is that the companies fail to respond within 30 days at which point the credit bureaus are required by law to remove the item from your credit report. Sounds good right? Well not exactly; the fact of the matter is that you typically you do owe the money to the creditor (unless the claim was fraudulent in which case you should dispute it!) and the item will more than likely pop back onto your credit report in the future.

After the first month of letters go out disputing all of your charges on your account, the credit repair company will then send out a 2nd set of letters and continue the same process hoping that creditors that responded before will once again respond and of course they’ll charge your card for another month of their service. I’m just not a fan… I’ve seen these companies bill customers for months and months and I think you’re far better off just not paying for their service and fixing your credit on your own. It’s not that hard and disputing legitimate items on your credit report is not a practice I support.

If you’ve read this far, then you must be serious about wanting a home and fixing your credit! There’s no such thing as an overnite credit fix… it’s going to take time. How much time? It depends on how bad your credit is; on average probably 6 months… for some it will take less and for some it will take longer but either way the goal is the same!! Let’s turn you into a HOMEOWNER!! Doing something that takes time requires motivation…. Your motivation on my website is to become a homeowner, so the first thing I want you to do is print out a picture of a home and put it somewhere you’ll see it EVERY DAY!! (refrigerator, desk, nightstand etc). We’re going to stay focused and remember why we’re doing this!! We want a home!!!

The next step to take is to find out exactly what your credit looks like. To do that you need to request a copy of your credit reports from each bureau, the ONLY site to do this from is https://www.annualcreditreport.com/index.action 

Once you receive your reports you can find out exactly what you need to work on. There are really only a few reasons you have good or bad credit. Either you have items in collections that you haven’t paid, you have late payments on credit accounts, don’t have anything helping you build positive credit or you’re simply not using the credit that you have.

You need at least 2 positive tradelines on your credit that you’re using and paying ON TIME every month. What’s a positive tradeline? It’s simply a credit account (could be a car loan, could be a credit card, secured credit card, student loan, personal loan etc…) that you pay on every month ON TIME! (NOTE: if you bought a car with a buy here / pay here they may not be reporting that loan to the credit bureau, oftentimes they do not!!).

You DO NOT need to carry balances on credit cards but you do need to use those cards every month. Buy a tank of gas or a loaf of bread and pay off that card before your due date. There are no brownie points for paying interest on credit cards when it comes to your credit score. On time payments is the ONLY thing that matters!!

If you don’t have 2 positive tradelines then the next step is to establish them. We do this one at a time and my recommendation is to use a secured credit card for this purpose (PLEASE PLEASE PLEASE do NOT go out and buy a car right now or furniture!! You want a home so KEEP your focus!!). Typically the easiest secured credit card to obtain is the Discover it card, visit this site to view options (note: I have no affiliation with Nerd Wallet whatsoever): https://www.nerdwallet.com/best/credit-cards/secured

Once you obtain your first secured credit card, buy a tank of gas, loaf of bread or a cup of coffee and pay it off on time. If you still need a 2nd positive tradeline then you’re going to apply for another secured credit card after 2 months and do the same thing: Tank of gas, loaf of bread on each card and paid off ON TIME!

Now that you’ve obtained your credit reports and you’re working on getting your secured credit cards to start building positive credit it’s time to start cleaning up your derogatory items on your credit report.

Make a list of all derogatory accounts from smallest dollar amount to largest dollar amounts. It’s time to start negotiating!!! Many folks’ tendency when cleaning up credit is to simply start writing checks to the creditors to pay off items… DO NOT do this!! This WILL NOT HELP!!

Instead, we want to call the debt holder and ask them if there’s an amount they would accept for payment in full in exchange for deletion from our credit report? THIS IS THEY KEY! We need these items deleted…. If they say no, that’s OK, just call the next debt holder on the list. The phone numbers are on the credit report. If they say yes, then get a letter IN WRITING from them, send them the payment (use a cashiers check) with tracking, return receipt requested and then keep GREAT RECORDS for the rest of your life as someone may call you down the road about this debt. DO NOT give them electronic access to your accounts!!  Then repeat the process continuing down your list.

The answer to this is understood by understanding collections. Let’s say you borrowed $1,000 on a capital one credit card and then lost your job and couldn’t pay the card. The late fees and interest started racking up and you ignored the letters over time. Eventually Capital One will send you off to their collections department who will attempt to reach out to you to settle the debt. If they’re unsuccessful then they’ll eventually sell your debt to a debt collection company… but for how much? Typically they’ll buy the debt for around 10 cents on the dollar. Meaning they’ve made a business decision to cut their losses and they’ve now accepted $100-200 for payment in exchange for your debt. The debt collection company will come to you stating that you owe them the $1,000 plus all the interest and fees that have been tacked on which could now look like $1,500-2,000 depending on how long it’s been. 

The debt collection company is a business; they’re in place to make money. Something is better than nothing so oftentimes they will negotiate a payoff for you that is much less than what you even originally owed to Capital One. Offering them $250-500 for payment in full AND deletion from your credit report is not unreasonable and paying this amount that they’ve agreed to means you’ve fulfilled your debt obligation (but again, you need everything in writing!!). 

Last word on negotiating with creditors: Keep EVERYTHING for the rest of your life in your files. These things have a way of turning back down the road of life and you may have to provide proof of payment down the road.