Buying a house is potentially one of the biggest decisions you ever make in your life. It is a major cornerstone and something you will always remember, but if you have a bad credit score then the whole process can be much more difficult.
Not only can a poor credit score stop you from being offered the mortgage you need, but it can also prevent you from accessing the best rates and promotions for mortgages.
In extreme cases, you might find your dream house, and when you try to raise the funds via a mortgage, you can get declined and find that you don’t have the funds behind you to make an offer. This is true even if you know that you can afford the repayments. Unfortunately, a credit score follows you around and if it is not up to scratch, mortgage companies are going to either ask you to pay a lot more in interest or say no altogether.
Nobody wants to miss out on their dream house because they have a bad credit score. In this guide, we’re delving further into how your credit score actually works, how it impacts your prospects of buying a home, and what you can do to restore your credit to healthy levels.
What is Credit Score and How is it Calculated
A credit score is a simple numerical value that represents your history and “creditworthiness.” It is how companies work out whether or not you are likely to pay back loans, and what you are like when it comes to financial commitments. The value is between 300 and 850, and you are given a score based on a number of criteria, maintained by credit agencies in the U.S.
It is not exactly known how the algorithm and criteria work for calculating a credit score. These are something of industry secrets, but people have worked out within a degree of accuracy how the score is calculated.
Payment history is the biggest factor that is considered for the algorithm to work out your credit score. It takes into account whether you’ve ever gone to collections, or if you have been bankrupt before (in the last 10 years, eventually bankruptcies are removed from the account). This will also consider if you’ve failed to pay back loans before, and if there are a significant number of problems with this then it is likely you will have a weaker credit score.
After considering the payment history, the amount you currently owe, compared to the credit you have available to you, is also considered. This means if you are the sort of person who has maxed-out credit cards you might be seen as a risk. Lenders like it if you use below 30% of the credit that is available to you. This seems to be taken into account hugely in the algorithms. The percentage of debt isn’t the only thing considered here, as the number of accounts you have and whether they have had issues with payments can also impact the score.
The length of your credit history is also a very important part of the credit score calculation. If you have had an account open, in good standing, for 10 or more years, it is much better (and safer) than someone with a couple of years of history. People are rewarded if they’ve reliably repaid for years.
New credit that has been applied for is also taken into account, but not too much. Every time you apply for credit it can indicate that you are under some pressure to raise money, which can be a worry for potential lenders. Think about whether this new credit is worth it every time you borrow.
Lenders and credit agencies also consider something called the “credit mix” which indicates whether you are able to manage lots of different types of credit such as auto loans, cards, retail cards, and other lines of credit like overdrafts. Being able to manage numerous types of content is a good sign for lenders.
Read more: How to Pay off Debt Fast
What Affects Your Credit Score
So, with a rough idea of how the calculations are made, you can see the sort of things that might impact your credit score and cause you to have a lower standing with credit agencies.
There are many examples, from the extreme (going bankrupt) to smaller activities like simply applying for a new credit card or automotive loan (even if you don’t take it in the end).
You can work out some of the behaviors that lenders want to see from the algorithm calculation above, but what are some of the other ways your credit score can be affected? We’ve listed some of the common negative examples below, and the things that can cause a drop in your credit score:
- Maxing out your credit card. Even if you just have one, with a relatively small line of credit, if you max it out, it can show that you don’t have a lot of control over your finances. It is often better to have a larger credit limit but use less of it.
- Applying for lots of credit cards. This is another signal that you are perhaps losing control, or applying out of desperation.
- Forgetting to pay back on time. Even if you have enough money, if you forget to repay your minimum payment or agreed loan repayment then you can end up with negative impacts on your credit score.
- Never getting a credit card. Some people deliberately get a credit card to use it for a few things and build up a history of repayment. This can show that you are reliable when it comes to repaying the money.
As you can see, a huge amount of what goes into your credit score is around reliability. If you behave as expected with one loan, it is likely that you will be able to get another in the future, whether in the form of a credit card, or a mortgage.
How to Fix Errors On Your Credit Report
Credit bureaus who are responsible for keeping your credit report and generating your credit score must also act if there are errors on your score. You will need to contact the credit bureau once you have accessed your credit report, and they must change your report under the Fair Credit Reporting Act.
You’re entitled to see a credit report from each of the major bureaus once a year, free of charge, and once you tell them about something that is not accurate they have limited time to make the changes.
You can file your dispute online with all of the agencies, and they usually have to investigate within 30 days, unless the dispute can be deemed “frivolous”. Make sure you don’t just try to dispute everything or they may not take it seriously.
To increase the chances of things that are incorrect or outdated on your report getting removed, you should:
- Provide copies of supporting documentation (don’t provide the originals).
- Clearly identify and label the items you wish to dispute.
- Let them know why it is disputed.
- Make clear that you want a deletion or correction of this item of the credit report.
- Enclose a copy of the report with the item you are disputing highlighted, to help explain what you are talking about.
You can do the report dispute via letter. There are some templates online that can help you to very quickly put together a letter before you send it by certified mail.
The letter should follow the same process and include the same information. Once it has been received it will usually take the bureaus 30-90 days to remove the disputed information (if they decide that your dispute is accurate).
In a lot of states, you can also get a free credit report after the dispute is registered, to help you to verify that it has been removed when requested. The key is providing loads of evidence wherever possible.
Often, people who are looking to buy a house can approach the credit bureaus in advance. While you can’t necessarily repair 10 years’ worth of bad habits related to your credit report, it is possible to get rid of any inaccurate information, and this is one of the quickest ways in which to potentially improve your credit score. This is called credit restoration.
This means a few months before you are looking to request or apply for a mortgage, you can do your due diligence on your own credit report and try to make yourself look like a more appealing option for the lenders.
Can Bad Credit Affect the Mortgage Rate?
In an ideal world, people who have a poor credit history and a low credit score would wish to start again. Unfortunately, it doesn’t work like that. If you have a poor credit rating in the first instance then you are unlikely to get access to the best rates.
Consider the following:
- A credit score of 740 or above is considered excellent credit.
- A score between 700 and 739 is good credit.
- Scores between 630 and 699 are known as fair credit.
- And scores of 629 or less are poor.
This is what lenders use to categorize potential borrowers. The credit rating system gives them a way to see, at a glance, whether or not it is likely that they will be working with someone who is likely to pay back on time, and reliably.
The credit scores tend to be split into categories every 20 points. This can impact whether a company gives you its best rates or not. Some mortgage companies will have tiered lending options and the higher your credit rating, the more likely it is that you will be within the lowest repayment tier.
How come companies are able to do this? While it may not seem totally fair to some people who are being judged on mistakes of the past, it makes sense that it costs more. Banks and other companies that offer lending need to mitigate risk, and one of the riskiest behaviors for them is lending to people that might not actually pay the money back.
You may be tied into a mortgage for decades, and even a fraction of a percent can make a huge difference when it comes to paying back your mortgage and how much money you will pay out in interest, so it makes sense to work hard to improve your credit score first.
Unfortunately, there are also plenty of examples whereby lenders will see people with poor or even fair credit ratings as just too much of a risk to work with, and this is what can cost you the dream house you have your heart set on.
Tips to Buy a House With Bad Credit
Bad credit doesn’t have to be the end of your pursuit to buy a house. There are things you can do to try and make your application stronger and more likely to succeed.
So, what are some of the ways you can buy a house with bad credit?
Try to Find FHA Loans
This is lending that is insured by the Federal Housing Administration, designed to make it easy to get a mortgage with a lower down payment, and sometimes for lower credit scores. You will still need a credit score of over 580, but this is more achievable than some of the scores required by other lenders. Some people have even accessed this type of lending with credit scores as low as 500.
Certain lenders work with the FHA to provide these loans, but they are not necessarily obligated to do so. It’s no guarantee that you are going to get a mortgage, but it is another helpful way to attempt to get the money you need.
Buy With Someone
This helps if you are looking to buy with a partner. By having both of your names on the mortgage, it can sometimes help you to get the loan you need. This is especially true if they have a better credit score than you.
Of course, this doesn’t mean that you can just rope anyone into helping you, but it is possible that you can buy your property with a spouse, or sometimes even with a friend if it is what you both want to do.
Get a Bigger Down Payment
This is easier said than done, but larger down payments show that you are serious about the property, and also that you have been able to stay disciplined and save a lot of cash. A bigger down payment is also a way to reduce how much you have to borrow. That smaller sum of money could make all the difference, as lenders might see it as less of a risk to let you borrow it.
It may set you back some time, but if you are in a position to save for longer (an extra year or two, for example) then you might find that lenders are far more willing to lend you the money you need.
Address the Credit Score
Sometimes it can take years to recover a poor credit score. Sometimes, in the space of a month or two you may be able to make some difference. The two main approaches include:
- Improving your habits and making sure you understand how your credit score is generated. Things like reducing the percentage of lending you have used makes a huge difference. Of course, repaying on time and improving other financial habits can also make the difference and boost your score, but this is a long-term game.
- Increasing your credit score by removing outdated or inaccurate information from your credit report. There could be things on your credit report that you can dispute, and this can make all the difference. This is sometimes completed as quickly as 30 days in the future, and credit bureaus have a duty to look into complaints as long as they have some grounding.
A lot of the tactics to secure your mortgage are long-term games, so if you are looking to borrow money tomorrow and your credit score is not up to scratch, you are likely to face a losing battle. Credit recovery and credit restoration can take time, so if you start the process when you start looking for a house, or even before, there’s every chance that you will be in a stronger position when you need to apply for your mortgage.
A credit score doesn’t have to be the end of the pursuit of your dream house. Buying property is something that many of us dream of, and is a proud moment when we achieve it. Getting a mortgage may be a challenge for people with a poor credit score, but there are plenty of things you can do in order to make it more likely, and shopping around for mortgages helps to increase your chances of being approved. That dream home might be closer than you thought.