One of the most common questions people ask real estate agents is, “What credit score do you need to buy a house?”
It’s a great question. While ValuePenguin.com reports the average credit score in the US is currently 711—and those numbers are steadily rising year over year. That’s a good credit score to buy a house! But according to BadCredit.org, 34% of Americans have a credit score of less than 600. That means a huge chunk of individuals are unable to obtain a mortgage, thus, making buying a house or real estate investing a difficult task.
So, can you buy a house with bad credit? Well, there’s good news, and there’s bad news:
- The good news is, YES, you can invest your money in real estate with bad credit (explained later in this post).
- The bad news is you probably shouldn’t. Unless…well, more on that later. But first…
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Qualifying for a traditional home loan
If you’re looking for a traditional fixed-rate mortgage, you will likely need a FICO score of 620+. Still, there are other lending options that may allow you to buy a home with a lower credit score or with less money down. These include:
- FHA loans: 580+ credit score qualifies for 3.5% down (lower than 580 may require 10% down)
- VA loans: Most lenders want to see 580–620
- USDA loans: Most lenders want to see 580–640
- Fannie Mae HomeReady: (for low and moderate income borrowers) 620+ can qualify for 3% down
How lenders define credit ranges
While there are multiple methods for scoring credit, FICO defines credit ranges as follows:
- Poor: 579 and lower
- Fair: 580–669
- Good: 670–739
- Very good: 740–799
- Exceptional: 800+
The truth is credit score is merely a number that represents your financial ability to manage your money. If you fall into the poor or fair range, you may need to do extra work to prove you are worthy of a home loan. Working to improve your credit is your best option.
6 ways to improve your credit score to buy a house
Bank loans may be tough to get, but it’s hard to beat the low interest and long terms that a bank can provide. Maybe today you don’t need it but down the road, once you choose to invest in real estate on a larger scale, you are going to wish you had great credit.
There are a billion articles on how to improve one’s credit score, so no need to go too deep on that here. But the following tips should help:
- Commit to fixing your debt problem. This will not be easy. Are you willing to do what it takes?
- Start making more income. Yes, that means you might have to put in some extra hours at work or find other ways to hustle. You need to get current on all outstanding debt and pay off what you can.
- Lower your balances. Make sure the balance on all of your revolving debt is less than 30% of the limit. High debt-to-limit ratios make your credit worse.
- Stop applying for credit. Seriously, stop. It hurts your score.
- Pay everything on time, no matter what. It shouldn’t matter if your child is sick and your leg falls off on the way to bring him to the hospital. You need to pay every bill on time.
- Consider getting a secured credit card. Once your debts are current or paid off, consider obtaining a secured credit card. A secured credit card has a maximum limit of whatever dollar amount you deposit with the lender. In other words, you give the bank $500 and then they give you a $500 credit card. Use this to buy your gas, groceries, and a few other things—and then PAY IT OFF IN FULL EVERY MONTH. This is your way to start building trust with the credit world.
Repairing your credit is going to take time. There is no doubt about it. But if you commit to the process, it can be done. Soon, bad credit will be just a memory.
How to buy a house with bad credit
If you still would like to buy a house or invest in real estate, here are five ways that it can be done with not-so-great credit.
1. Try a partnership
Partnerships are one of the best ways to invest in real estate because everyone has something they are lacking. Partnerships help fill that void. For you, perhaps it is your bad credit, but maybe you have something that your potential partner doesn’t have. Time? Skills? Hustle? What can you bring to the table that will help them achieve their goals while you achieve yours?
Of course, when it comes to partnerships, one must be careful. Do your homework, vet your partner carefully, and as is true with all these tips, only invest in great deals.
2. Consider seller financing
Seller financing is the process in which the seller agrees to finance the property, rather than making you obtain a new loan. In essence, the seller agrees to let you make monthly payments to them until the property is paid off (or the term of the seller-financed loan ends).
Seller financing can be powerful, as sellers typically will not ask to see a credit score. However, the best use of a seller-financed deal is when the sellers own the property free and clear. In other words, they should not have a mortgage on the property. If they try to “carry the contract” on the home that they have an existing loan on, their lender could foreclose due to something known as “the due-on-sale clause.” So look for deals where the owner has no mortgage.
Seller financing will likely become increasingly popular in the coming years, as baby boomer owners of rental properties will be looking to get out of the game—but also looking to hold on to their monthly income. Seller financing offers a great win-win solution for all parties.
3. Look into hard money lenders
Hard money lenders are individuals or businesses who lend money at high interest rates and short terms to real estate investors. Hard money rates vary, but typically fall between 10% and 18% interest, with less than two-year terms (often just six months). In addition, hard money lenders also charge large fees, known as “points,” which can add anywhere from 3% to 10% of the loan amount. Many hard money lenders used to be investors themselves, but have moved to the more passive method of simply lending.
Sounds nice, doesn’t it?
Because of the high rates, high fees, and short terms, hard money is ideal for house flippers and those looking to do the BRRRR (buy, rehab, rent, refinance, repeat) method of real estate. This way, the real estate investor can be in and out quickly, cashing out the hard money lender and moving on to the next project.
Hard money lenders rarely look at the borrower’s credit score, though it is becoming more common. In reality, the hard money lender cares most about the security in the deal. They want to know that no matter what happens, they will make money. If the borrower defaults, can they foreclose and sell the property for more?
If you have a low credit score but want to flip houses, hard money might be a great option. Just be sure to find an incredible deal so the lender feels secure, and then rock that flip and make your money.
4. Explore private money lenders
Similar to hard money, private money lenders are individuals you might know and are looking to achieve a good return on their investment. Unlike hard money lenders, private money lenders are not typically real estate professionals who lend money for a business. They are looking to diversify their cash into other investments. Private money lenders might be your dentist, mom, neighbor, or someone you’ve built a relationship with on BiggerPockets.
The keyword with private money is relationship.
When dealing with other people’s money, it’s unlikely they will ask you for your credit score. However, this means you must work even harder to make sure they receive the kind of return on investment they are looking to make.
This is when the discussion earlier about the credit score being a symptom comes into play. Don’t take advantage of Grandma’s kindness and lose all her money. In fact, never taking money from anyone who couldn’t afford to lose it. That would make for an awkward Thanksgiving dinner.
5. Check out wholesaling
Wholesaling is the business of finding great deals, putting them under contract, and quickly “flipping them” to a cash buyer for a higher amount. Many wholesalers do this entire process without using a single dollar of their own money or ever needing their credit checked.
This probably sounds amazing to you, but before you head out the door looking for a good deal, understand a few things:
- Wholesaling is a job. It is NOT passive, and if you don’t work, you don’t get paid! Most would say that wholesaling isn’t even investing since you are not really buying or selling the property.
- Wholesaling is hard. It requires time, patience, and great marketing skills. You also must have the ability to talk with sellers on the phone, sell yourself as a credible solution to their problems, estimate rehab costs, find cash buyers, and put the whole thing together without it all falling apart. In other words, wholesalers need to be good at the entire world of real estate investing. It’s not an easy task, and most people who try to wholesale never do a single deal.
- There are legal implications regarding wholesaling and the need for a real estate license. Simply put, you should probably get your license.
A low credit score doesn’t mean you can’t buy a house—or invest in real estate. It just means you need different strategies. And you should also carefully consider whether buying property is the right solution for you right now.
More on credit scores from BiggerPockets
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.