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Buying A House With Bad Credit

Owning a home can have a transformative effect on individuals. Research indicates that homeownership "boosts the educational performance of children, induces higher participation in civic and volunteering activity, improves health care outcomes, lowers crime rates and lessens welfare dependency."[1]

All of these benefits are particularly appealing to those who have a low income, bad credit, or in many cases both. For those individuals, homeownership and the added benefits of counting oneself among America's 87 million homeowners may seem like a far off, unattainable dream. The reality is that the financing needed to purchase a home would be effectively out of reach for many of those with low incomes if assistance were not available.

However, the US Government sees homeownership as not just part of the American dream, but increasingly as a right, and as a method of addressing persistent poverty. Programs designed to help promote homeownership have allowed even those with a poor financial record to find some assistance and still get into a home. Those seeking help can find it, but they will have to accept certain conditions and limitations.

Here's Why It's Difficult:
Buying a home with bad credit because of risk is hard. Unless you are paying for a home completely with cash, you will need to borrow money to make that home purchase. Before you can borrow money, lenders (usually banks, but often companies that lend money specifically for home loans) will need to look at your financial condition, including examining your household income and any other outstanding debts you may have. Your credit score is always going to be the number one factor for lenders.

Why Is Credit Score So Important? Your credit score tells a lender how trustworthy you are. It includes your lending history, including whether you have any missed payments, liens, bankruptcies, inquiries from lenders, and any negative remarks or comments related to other debts you've incurred. The more negatives you have, the worse your score will be.

Some criteria are beyond your control. A short borrowing history will have an impact, as will the number of borrowing accounts you have. For someone who is young and just getting started in life, this can mean starting life with bad credit or a mediocre credit score even if you have paid your debts on time, a situation that can seem very unfair. Unfortunately, the system works this way. However, there are ways to work within this system, making homeownership for those with bad credit an option.

Where To Start:
Start with your credit report - it's what lenders will see, so you need to understand it. You are entitled to free credit reports, which will give you a look at the same picture lenders are seeing. When you pull up your report, here's what you will see.

Raw Score - This number is usually prominent and ranges from 300 to 850. If yours is anywhere between 300 and 579, it will be considered bad.

Factors - These are the elements that make up your total score. They're not all weighted equally. Credit card history and utilization, for example, have a very high impact, while the total number of accounts has only a small effect. Here are all of the areas affecting your total:

Card Utilization (High Impact)
Payment History (High Impact)
Derogatory Marks (High Impact)
Age of History (Medium Impact)
Total Accounts (Low Impact)
Inquiries (Low Impact)

Here's a short explanation of each of these factors:

Card Utilization - This is a measure of how often you use your cards, with a heavy emphasis on how large a balance you carry. Very little usage is bad, but so is being maxed out at the end of each month. Using your cards moderately (30% utilization), never maxing them out, and paying the balance each month leads to a better rating here.

Payment History - This is a measure of how often you pay your accounts on time. Late payments have a negative impact, and this is recorded for every 30-day cycle, for every card or other lending accounts that you have (such as car loans).

Derogatory Marks - There are possible "derogatory marks" you might have on your account, including accounts turned over to collection agencies, bankruptcies, foreclosures, tax liens, and others. Any time you fail to make scheduled payments, and it leads to something more than just a late payment, you will receive derogatory marks.

Age Of History - This is, unfortunately, hard to get around. The rating agencies will take the average age of all your open accounts. Under four years is considered bad, while 7-8 years' average or older is good. Having no borrowing history at all has a powerful negative impact.

Total Accounts - This is a simple count of how many lending accounts you have had in your history, whether still open or closed. Fewer than ten is bad, while more than eleven is good.

Inquiries - Any time you attempt to open a new line of credit, you will receive an inquiry. These types of inquiries, known as hard inquiries are the ones that count. Soft inquiries, coming from those agencies that look at scores for other reason beyond opening credit lines or loans, do not count against you. Having too many hard inquiries in a short period reflects poorly on your score. 0-2 is considered good, while five or more is seen as bad. While the impact of inquiries is low, you should examine the consequences of multiple queries before shopping around for loans.

It's important to understand your score, what factors are influencing it, and why. You may see mistakes, inconsistencies, or even fraudulent activities that could be negatively affecting your score. If you have a bad score, you may still find some consideration from some lenders, but you may need to be able to explain why your score is what it is, what you are doing to fixing it, and why it is not a good measure of your trustworthiness. Showing that you understand your score and have a plan to improve it makes a positive impression. Still, this will not be easy. Expect many rejections, often without the opportunity to make your case. It may seem unfair and disheartening. However, patience, persistence, and a keen eye for researching available options will make the process less complicated.