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When Bad Credit Keeps You from Homeownership

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Melissa was about to try and live the American Dream. Eager to buy a house, she applied for a pre-approved bank loan only to discover that an old unpaid bill that she resolved two years ago is still lingering on her credit report. That’s dragging down her score.

And she’s getting desperate.

“I can’t buy a house without . . . these things corrected,” she wrote in response to a recent story on Credit.com. “Please, please help!”

Most Americans understand the financial and emotional importance of buying a home. Even though the rate of homeownership has declined from a height of 69.2 percent in 2004 to 65.5 percent in the second quarter of 2012, according to the U.S. Census Bureau, it remains the case that a solid majority of Americans prefer owning a home to renting.

“Traditionally, owning has won out over renting for many reasons,” says Gerri Detweiler, Credit.com’s consumer credit expert. “Owning a home is still one of the main ways that Americans build wealth over time.”

But some credit experts are wondering: What’s the rush? At Credit.com, we receive emails, blog comments and forum posts from people with damaged credit scores asking how they can buy a home. And in most cases, the question is asked with a sense of urgency.

Many readers with low credit scores don’t just want to buy a home. They want to buy a home now. Steve Campbell, who wrote in August that he and his wife recently filed for Chapter 13 bankruptcy, asked, “Can we buy a home anytime soon?”

But Barry Paperno, a credit expert and Credit.com’s community director, wonders whether that’s really the right question to be asking. Perhaps a more relevant question, Paperno says, is “Are you sure that your financial situation will be stable enough to make those monthly payments for the next 30 years?”

Homeownership has many rewards, but consider the risks, Paperno points out. Unlike during the mortgage bubble, buying a home these days usually requires a significant downpayment, and owning it may require substantial investments in renovation, maintenance, insurance and property taxes. If a homeowner loses a job or her income goes down, and she finds herself incapable of making those monthly payments, all of the money she’s invested could be lost, Paperno says.

In addition, if a renter finds he can no longer pay the rent, he can simply move out, possibly losing his security deposit. But leaving an apartment is rarely an event that’s recorded on a consumer’s credit report, whereas losing a home to foreclosure causes serious damage to a credit score.

“It can knock more than a hundred points off your score, and you will not be able to get another mortgage for another few years,” Paperno says. “If you’re buying a house for security, what happens if you lose your job? How secure is it, really?”

Buying a home still makes lots of sense for the average consumer, Paperno and Detweiler agree. But in some cases, consumers with low credit scores might find it makes more sense to put off purchasing, especially if they are getting turned down for loans, or if the interest rate offers they’re receiving now seem exorbitantly high.

“If you’re willing to wait just a little bit longer, even 18 to 24 months, you can boost your credit, you may be able to get a better rate,” Detweiler says.

There is a counterpoint to this argument, however. In today’s weak housing market, an interest rate of seven percent might be abnormally high, especially when people with the best credit scores can get interest rates as low as 3.49 percent, according to Freddie Mac’s latest report. But Detweiler had great credit when she bought her home in the late 1990s, and her interest rate then was seven percent.

Which is to say that just because you don’t qualify for today’s record-low interest rates does not necessarily mean that you’re getting a bad deal.

“You may have a tradeoff where you’re paying more in interest, but you’re still taking advantage of lower overall home prices,” Detweiler says. “So it still may be a good idea to buy as long as you get into a decent loan for the long term.”

Whatever you eventually decide, it may be best to slow the process down and make sure that buying is the right idea for you in the short term, the credit experts say. The American Dream has a strong pull, as do home prices that have lost much of their housing bubble value. But don’t let the dream of homeownership make you feel rushed to make a decision that could hurt you for years to come.

“Don’t be discouraged,” Detweiler says. “If now’s not the right time for you to buy, that doesn’t mean that you will never own your own home. A couple of years can make a big difference.”

Image: sun dazed, via Flickr

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