One of the most common questions I am asked each week on the live BiggerPockets Webinar is simply, “Can you explain how to buy a house with bad credit?”
It’s a great question. While ValuePenguin.com reports the average credit score in the U.S. is anywhere from 673 to 695 (depending which credit report is used), with those numbers steadily rising year over year, a large chunk of Americans still 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, I have good news, and I have bad news:
- The good news is YES, you can invest your money in real estate with bad credit. Later, I’ll explain five ways to do it.
- The bad news is you probably shouldn’t. Unless… well, we’ll get to that. But first…
What Exactly is Bad Credit and Why Do You Have It?
Bad credit can happen for a variety of reasons. Perhaps medical bills or maybe identity theft caused the issue. Maybe a person lost their job and had to miss some payments. The economic recession that started in 2007 led millions of Americans into financial difficulties, destroying millions of credit scores in the process.
But also, sometimes bad credit is caused by good, old fashioned stupidity and ignorance. A credit card here, a credit account there. Vacations, new clothes, and other “need-it-now” luxuries have caused thousands of people to lose their good credit score and wind up in a rough spot.
So what do banks view as “bad” when it comes to credit? 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+
Do you fall into the “poor” range? No matter what reason you have for having low credit, it doesn’t matter anymore. It’s done. You have bad credit. But the real question is:
Is your bad credit a symptom of a greater problem?
I ask this because most of the time, it is. It’s a symptom of greed, selfishness, impatience, and other terrible money habits.
What if everyone’s credit score was suddenly boosted to 800 and 100 percent of their debts were wiped out? What would happen? Within three years, you would likely find the same people with the same low credit scores and high debt.
The truth is, credit score is merely a number that represents your financial ability to manage your money.
Your credit score is just a symptom of a greater problem.
Now, before you think I’m being a jerk, leave this post and go back to watching Dancing with the Stars, understand that I’m not just talking to you. I’m talking to ME, as well.
I haven’t always had good credit.
When I graduated high school, I fell into the debt trap that many college students do. Student loans, credit cards, and in-store credit. I needed certain things, so I bought them. Sometimes I would forget to send a check, and I’d get hit with a late charge and a declining credit score. Other times, I would use one card to pay another. I quickly maxed out several credit cards. It was a dangerous game.
It wasn’t until I read Dave Ramsey’s book The Total Money Makeover that I realized I had a problem and I needed to change, so I did. Today I have a mid-700s credit score and haven’t had an issue in years. But I still remember what it was like to struggle with that credit score.
Can you identify with that? Then keep reading.
Have You Recovered From Your Debt Disease?
The reason I bring all this up is because what I’m about to teach you is powerful. It does work. There are many ways to buy a house with bad (or no) credit. However, it’s not going to matter at all if you haven’t first addressed the underlying reason for why you have bad credit. Perhaps you were young and dumb, and you’ve grown up but haven’t been able to raise the credit score enough yet. Or perhaps it truly was 100 percent not your fault, and someone stole your identity (but I doubt that).
The point is: Take some deep reflection and look at your life. Are you truly over the cause to your bad credit? Answer that question honestly, and until you can totally and completely say yes, don’t buy a house. To help you answer that question, ask yourself these three things:
- When is the last time you put something other than food on a credit card because you didn’t have enough money to pay for it?
- When is the last time you read a book on credit repair?
- What does your written budget look like? (What? You don’t have one? Uh oh…)
Real estate investing will NOT solve your bad money habits, and anyone who says otherwise is trying to sell you something.
Now, before we get to the five ways to buy a house with bad credit, let’s talk about how you are going to improve your credit.
Trying to Buy a House With Bad Credit? How About Improving Your Credit Instead?
In a moment, I’m going to share some great techniques for investing in real estate that don’t require any credit score. So why do we care about improving your credit?
Because soon you are going to want that sweet, sweet bank money.
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 if you choose to invest in real estate on a larger scale and you are looking to finance that 60-unit apartment building or the million-dollar house, you are going to wish you had that great credit.
Besides, if you are unwilling to work to improve your credit, it simply means you haven’t recovered from your debt disease, and it’s going to kill you financially. You might as well go back to playing Call of Duty with your buddies.
There are a billion articles on how to improve one’s credit score, so I don’t need to go too deep on that here. But the following six 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 and 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. I don’t care if your child is sick and your leg falls off on the way to bring him to the hospital. You will 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 is a credit card that 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.
What Credit Score Do You Need to Qualify for a Traditional Home Loan?
If you’re looking for a traditional fixed-rate mortgage, you will likely need a FICO score of 620 or above. 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: 58o or higher 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 or higher credit scores can qualify for 3% down.
How to Buy a House With Bad Credit
Now, for those of you who HAVE made a change deep within your heart and soul and are working on improving your credit, let’s talk. If you still would like to buy a house or invest in real estate, let’s discuss five ways that it can be done.
1. Try a partnership.
Partnerships are one of my favorite 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 they don’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. Getting into bed with the wrong person can make you both incredibly dirty! 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.
I believe seller financing will 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. It’s part of how I financed my 24-unit apartment complex with almost no money down.
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 percent 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 simply are looking to diversify their cash into other investments. Private money lenders might be your dentist, your mom, your 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 really comes into play. Don’t take advantage of grandma’s kindness and lose all her money. In fact, I would recommend never taking money from anyone who couldn’t afford to lose it. That would make for an awkward Thanksgiving dinner.
5. Check out wholesaling.
Finally, let’s talk about perhaps the most popular method taught by the gurus for those with bad credit: 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.
If you are interested in wholesaling, don’t miss The Ultimate Beginner’s Guide to Real Estate Wholesaling. It’s pretty awesome.
Wrapping it Up
So, can you buy a house with bad credit?
Yes. However, if your bad credit is a symptom of something else, fix that first or you’ll never enjoy the true wealth that can come from real estate investing.
If you are serious about repairing your credit and building better money management skills, I’d recommend starting with The Total Money Makeover by Dave Ramsey, followed by The Richest Man in Babylon by George S. Clason. (And I don’t care if you don’t like reading—both books are also on Audible.)
What do you think? Is it ever a good idea to try to buy a house with bad credit?