Must Your Bad Credit Score Equal Real Estate Horror?
The answer is “no.” Having a bad credit score won’t prevent first-time home ownership, but improving it will ease the journey to your new address.
Let’s understand what credit scores are, note the habits that affect them, and illustrate the impact of your credit scores on your purchase of real estate.
Take note that credit scores, ranges, and other numerical data are current at the time of the writing.
An individual does not have a singular credit score. Different organizations (e.g. the US government and businesses) use unique mathematical formulas for their credit scoring system. So, let’s learn how a credit score is determined.
An individual is assigned a number that is calculated by the organization’s unique scoring system. The party that decides to issue a loan to you may check out several of your credit scores.
Credit scores range from 300-850+. A score higher than 690 is considered good credit. Learn about the credit score ranges that are classified as: bad, fair, good, and excellent.
The US government and some organizations offer a free credit report. These do not usually include your credit scores.
Credit-reporting agencies (e.g. Experian, Equifax, and Transunion) research peoples’ financial habits. Businesses and governments obtain their information from credit-reporting agencies.
The answers to the types of questions below are translated into numerical data which are fed into the mathematical formula that generates a credit score.
- Do you pay your bills on or before their due date?
- How much debt (e.g. student loans, car payments) do you have?
- What loans do you hold currently?
- Do you have new applications for credit (e.g. store credit cards)?
Find out what credit scores you have been assigned. If you use a credit card or have a major loan (e.g. automobile or student) the issuers can provide the credit score they assigned to you.
No credit card, car loan, or student loan? No problem. You can still get your credit scores by working with the US Department of Housing and Urban Development (HUD).
Improving your credit scores sounds overwhelming, just as saving the Earth does.
You can’t save the Earth on your own, but you can recycle and walk to nearby destinations instead of driving.
As with contributing to the planet’s well-being, think of improving your credit score in terms of these small steps.
- Pay your bills on time. If you are running low on money periodically (we have all been there), pay at least the minimum required amount.
- Pay back your loan(s) per the schedule in the loan agreement.
- Avoid signing up for store credit cards.
Most of us do not have enough cash available to buy a house, so we take out a loan.
A loan is a sum of money that is expected to be paid back with interest to the lender. Interest is the price you pay to borrow money. For real estate purchases, the lender is a financial institution or mortgage bank.
Lenders expect the borrower to pay them back. Lenders determine the creditworthiness (how likely they are to get repaid?) of a borrower based on the borrower’s credit scores.
So, you checked your credit score and you have an idea of your current creditworthiness. Now, you want to know what loans you can get and whether you can improve your credit score.
There are loans that are favorable to first-time home buyers. Some loans are structured to assist those with limited incomes or difficult financial situations.
These are backed by the US government.
Positive aspects include:
- A lower down payment
- Lower credit scores (equal to or greater than 500) are accepted
Negative aspects are:
- Mortgage insurance is required
- Conditions apply
Some conditions include:
- You have a steady employment history
- The FHA must inspect and approve the house
- The house must be your primary residence, not a fixer-upper.
These also are backed by the US government and aim to assist people with lower incomes who also want to reside in rural areas.
Positive aspects are:
- A down payment of $0
- Lower credit scores (equal to or greater than 640)
A negative aspect is that some mortgage lenders will not accept USDA loans.
Some conditions are:
- Having a specified income level
- The home and property must be considered eligible by the USDA
Check your credit reports for outdated or inaccurate information and have them updated. If you receive cash gifts at holidays or pick up a month’s worth of extra shifts, consider using the money to pay off outstanding credit card balances.
Yes, these small financial windfalls are wonderful opportunities for a little splurge. Yes, they could be used toward premium streaming services or more frequent takeout; however, think of living in your own house where you watch television and eat food (even if it is network television and frozen pizza).
If You Are New to Buying Real Estate, Seek Services and Take the Time to Talk
You’re a first-time home buyer with some unfavorable credit history resulting from choices that are in the past. You’re in the midst of paying down a mountain of debt, but a sticky note with own my home clings to your bathroom mirror.
You will get there. Seeking some help and taking the time to talk may be just the ticket you need.
If you are unsure of how to change your vehicle’s oil, you seek the services of a mechanic. If weeks of discord have become months of fighting, you may seek out marriage counselor recommendations.
Credit counseling is no different.
The National Foundation for Consumer Credit (NFCC) originated in the early 1950s in the United States with a mission to provide financial education and to teach best practices for using credit.
Many credit counseling services are nonprofit organizations and provide services that are free or require minimal payment. Credit counselors may be certified financial planners, have specialty designations or hold degrees in financial fields.
Credit counseling may include:
- Interpreting your credit report
- Understanding your credit scores
- Creating a budget
- Planning for wise use of your paycheck
- Consolidating and minimizing debt
You have a few options.
- The Office of the Attorney General in US states and commonwealths will have a listing of reliable credit counseling service providers.
- Locally-based consumer protection agencies are a great resource. Not sure how to get in touch? You can make inquiries at your local library or community center.
- Finally, interview the credit counseling service before you move ahead with taking their advice.
When you contact a credit counseling service, ask questions. There is no reason to be shy or embarrassed; these organizations exist to serve the public of which you are a part of.
- What services are offered?
- Can you email or mail more information to me?
- Are there fees for your services?
- Do you have payment plans if I can’t afford to pay for your services all at once?
- Is there a contract or agreement we sign, and where is it located?
- Are you licensed or accredited?
- How do you keep my nonpublic personal information (i.e., address, social security number, birth date, etc.) secure?
- What criteria do you use to hire your employees?
- Do you or your employees receive payment or commission?
When a Borrower, A Listener Be
While Shakespeare was not in favor of borrowing or lending, he didn’t have to live through the stock market crash of 1929 or the real estate-driven recession of 2007-2008. He was never tempted by a collateralized debt obligation (CDO). He wasn’t trying to refinance Stratford-upon-Avon in the wake of a global pandemic.
With all due respect to Shakespeare, we are going to skip his advice for now. We will replace his advice with when a borrower, a listener be. To whom should you listen? Listen to your lender.
The Players are the Thing
Continuing to skewer Shakespeare, we will borrow from him again. We’ll corrupt the famous phrase from Hamlet: “the play’s the thing” by focusing on the players in a loan arrangement. If you are borrowing money to purchase your first house, you will be working with a lender.
Simply put, for loans covering real estate, you are the borrower. Lenders are usually financial institutions or mortgage banks.
No matter the situation or the type of lender, all lenders have two requirements:
- Repay the amount of the loan, plus the interest
- Pay the monies owed on time (specified in a schedule in the loan agreement)
In The Merchant of Venice, Shylock is the miserly money-lending character, set on getting his pound of flesh from a character who defaulted on his loan. Predatory lending had a significant role in the subprime mortgage crisis of 2007-2008. However, today’s lenders have to operate within updated rules and regulations brought about by the banking reform in the wake of the recession.
Nevertheless, it is important to spend time listening to your lender. The lender’s role in setting up the loan includes these actions:
- Deciding the terms of your loan
- Selecting the interest
- Setting the payments schedule
As the borrower, you will be responsible for the loan, so you will want to be familiar with its components.
Speak with your lender about becoming pre-approved for a mortgage. Mortgage pre-approval is a process that determines how much money you can borrow from the lender, based on your financial health and the state of the house you plan to acquire.
Terms related to preapproval often are used interchangeably, but a clear understanding is warranted. Pre-qualification, pre-approval, and approval are not synonymous.
Prequalification is the phase in which you provide basic financial information, such as your annual income and the amount of money in your savings account. During prequalification, you don’t have to provide your credit score.
Preapproval is the phase in which you provide additional financial information, such as your credit scores, tax returns, bank statements, and pay stubs. Also, the lender will have a credit check performed. A credit check is an inquiry into any credit accounts you have (e.g. credit cards).
Approval is the final phase. This is an inquiry regarding the real estate (as opposed to an inquiry regarding your creditworthiness) be covered by the loan.
The inquiry includes the following:
- A property appraisal determines if the property value is accurate
- A title company search that identifies any existing situations (e.g. liens) with the real estate you plan to purchase
- An evaluation of the condition of the property to ensure it is safe for a resident
The good news is that you have some control over your financial future, especially when it comes to owning real estate. How do you have control?
You get to make choices to perform or not perform activities. What activities are these? You can decrease your debt, increase your income, and increase your deposit funds.
Let’s consider each.
We are not suggesting you take on two extra jobs to pay off your auto loan. It isn’t a great idea to increase your caseload in order to be named partner (and earn the salary of a partner) as soon as possible.
Decrease debt by focusing on the debts with the highest interest rate. In August 2022, the current average interest rate for credit cards was 14.39%, according to www.moneygeek.com, respectively (Lobell, 2022).
To carry $1,000 in credit card debt for one year at a 14.39% interest rate, you will ultimately pay $1,143.90. Said differently, you pay $143.90 per year for each year the $1,000 remains owed.
Increasing income is simpler than it sounds. Examples include the following:
- Picking up a few extra shifts per week at the factory, hospital, or warehouse
- Agreeing to work during time periods for which you may be paid extra
- Taking a course or two to earn a certification or distinction that will allow you to be paid more money for the expertise you have acquired (note that this pointer only makes sense if your employer will pay for the classes or you earn a scholarship)
- Taking advantage of money-earning situations that depend on the calendar (e.g. having a temporary retail job during the holiday season or offering tax preparation assistance before the month in which taxes are due)
Increasing deposit funds means that when you are a buyer who puts an offer on a house, you put more money down, improving the attractiveness of your offer.
Switch from being a buyer to a seller for a moment. You get two offers for a house that you are selling for $200,000.
The buyer with offer A will give you $15,00o at the closing and will take a loan for the remaining $185,000. The buyer with offer B will give you $10,000 at the closing and will take a loan for the remaining $190,000.
Offer A is better for the seller. Why?
Money to be paid through a loan is inherently riskier because it is to be paid in the future. Interest rates change, supply chains waver, gas prices rise and fall, and geopolitical stability is anything but stable. Any of the aforementioned plus hundreds of other variables can affect the buyer’s ability to pay back their loan.
Now, put yourself back into your dual role as the borrower/buyer of the real estate. If offer A is more attractive to the seller, you are motivated to increase your deposit funds (having more cash for your down payment).
This first blog post addressed the topic of buying real estate with bad credit by going for the TOP. We offered tips, options, and pointers to oust bad credit, avoid debt pitfalls, and get you on the road that leads to the driveway of your first home.
Continue going for the TOP by checking out my book, Essential Advice for Buying Your First Home and Navigating Through the Mortgage Loan Process.