How to Buy a House With Bad Credit

Regina Miller says she is tired of "throwing away $1,520 each month" to rent the two-bedroom apartment in Long Beach, Calif., that she shares with her 12-year-old son. So two years ago she set some goals, including making more money and buying a condo.

She's accomplished the first goal, supplementing her modest hourly wage managing a local gift shop with money she earns selling cosmetics part time. But at least for the foreseeable future, a house may be out of the question. "I thought for sure I could buy something," says Miller, who says her credit rating hovers around 580. "Everyone was getting loans. People with worse credit than me, even."

But the once booming housing market is now foundering in many cities, largely because buyers with shaky credit scores like Miller's have been defaulting on their mortgages in record numbers. That means the roughly 13 percent of Americans whose credit score is between 500 and 599 (read: not so good) and who not long ago might have qualified for a "subprime" loan may find themselves out of luck.

Consider last week alone: New Century Financial Corp., the nation's second biggest subprime lender, stopped accepting new loan applications. The Mortgage Bankers Association reported that new foreclosures are at a record high. And the stock market plunged as investors worried about the falling housing market's impact on the economy. Last month Freddie Mac, a huge investor in U.S. mortgages, said it would stop buying certain types of subprime loans. "As lenders tighten up, that's going to exacerbate the credit problems because on-the-edge borrowers won't be able to refinance out of their problem," says Mark Zandi, an economist at Moody's. So what are the credit-challenged-but-house-hungry like Miller to do? The options are limited:

Take the hot air out of the adjustable rate.
Many people are now in trouble because of "teaser" mortgage rates that start low but balloon after a certain amount of time, sending monthly payments skyrocketing. People had hoped they could refinance their rapidly appreciating new homes to cover the higher payments. But appreciation is now at a crawl, at best. Last month Freddie Mac said it would apply more-stringent standards to adjustable-rate mortgages (those, say, that allow for three years of low rates, but then increase significantly for the next 27).

Bring your pay stub.
In recent years, as the housing market boomed, lots of loans were handed out with little or no proof of income, which are called "liars' loans" by critics. The promise of appreciation was enough. That's no longer the case. By the end of the year, Freddie Mac will limit the use of what it calls "low-documentation underwriting," and "strongly recommend" that lenders put borrowers' tax and insurance payments in escrow accounts upfront.

Get smart.
Freddie Mac has two educational programs, CreditSmart and Don't Borrow Trouble, that can help consumers make sure they don't take out loans they'll be likely to default on later. For more info, go to

Raise your credit score.
Many subprimes today want a minimum score of 600 or 620. So pay off as much debt as possible and don't let your credit-card balances go above 33 percent of their credit limit. And start saving for that down payment.

For those already in danger of sinking in subprime debt, try your best to stay afloat; a lifeboat may be on its way. Sen. Christopher Dodd says he plans to introduce a law that would essentially allow you more time to solve loan problems before foreclosure. In the meantime, lenders urge troubled borrowers to keep in touch. It's in everyone's interest, they say, to keep you in your house. Try to work out a deal—your home may depend on it.