For Home LoansMany people believe that to secure a home loan (mortgage) you need to have an excellent credit rating, a low debt-to-income ratio with steady, significant income, and be in a position to make a substantial down payment. None of these is necessarily true. It's certainly easier to get a mortgage with a good income and a clean financial history, and you'll probably get a better deal if you have those on your side. Still, if your credit is less than perfect, or even if you have had a prior foreclosure, bankruptcy or short sale, there are programs out there that can help you secure the financing you need to purchase real estate.
What Is a Low Credit Score?Credit scoring is the method lenders use to assess the risk of default. Your score (a number between 300 and 900) is derived from your current accounts and credit history. While there are no hard lines between “good” and “bad” scores, a score above 650 is what creditors like to see. If your score is below 620, applying for new lines of credit becomes more difficult.
Many factors affect your score. Late payments, non-payments, your current amount of debt, types of credit accounts, a short borrowing history, and inquiries on your credit report, and any bad behavior such as writing bad checks will all count against you. Making payments on time, keeping your debt-to-income ratio in control, and other evidence of sound financial management will boost your score.
Many people do not know that they have issues on their credit reports. You should review your report regularly to identify any potential issues. All of the three nationwide reporting companies (Equifax, Experian, and TransUnion) are required by law to supply you with a copy of your report every 12 months if asked. If you find any discrepancies on your report, you should dispute them right away. The Federal Trade Commission (FTC) publishes a useful guide to help you with that process.
If your poor credit score is due to legitimate black marks caused by past financial dealings, you need a solid debt management strategy and sound financial planning to get yourself back on the right track for financial freedom. Part of that process is using credit responsibly, and borrowing money that you can and will pay back on time.
What Options are Available?It is important to realize that while you may qualify for a particular mortgage, a bad score is likely to mean that you will pay a higher interest rate and more fees than a person with a better score would. The lender sees you as a greater risk of defaulting (failing to pay the money back) and charges you more money to make up for that risk.
Here are several possibilities for you to consider:
Subprime MortgagesDespite receiving a bad rap for their part in the 2007-2008 financial crisis, subprime mortgages remain a viable option for people with bad credit. Subprime mortgages have interest rates that are higher than prime mortgages because lenders apply risk-based pricing when determining the terms and rates. The rate you pay depends on your credit score and circumstances.
Conventional (prime) mortgages can have fixed or adjustable rates, but subprime mortgages are nearly always adjustable. You'll have to consider this reality carefully when you are applying, as a seemingly low initial interest rate could become a much higher one further down the line.
The key with any subprime mortgage is to ensure you can afford to make your payments. As with any serious financial commitment, it pays to shop around before you put pen to paper on a particular deal.
FHA Home LoansFHA loans are designed to help first-time homebuyers and people with poor credit scores get a foot on the property ladder. These mortgages are backed by the Federal Housing Administration and are an excellent option for people looking to secure financing that requires a relatively small down payment with relatively easy qualification standards.
The size of your down payment will still depend on your credit score, but most borrowers can secure an FHA loan with a down payment of just 3.5 percent of the purchase price of the home. Borrowers can make their down payments with their savings or use gifts from family members or a grant from a state, or downpayment assistance programs from the government.
An FHA loan can cover closing costs, because sellers, builders, and lenders all have extra scope to cover some of the expenses. For example, a lender may agree to pay your closing costs in exchange for a higher interest rate. A builder might agree to do so as an incentive for you to purchase one of the new homes they've built.
The FHA is not a lender itself, so borrowers still need to obtain their mortgage through an FHA-approved lender. The important thing to note here is that even though different lenders offer the same FHA loan, their rates and terms will almost certainly differ. You'll still have to shop around to get the best deal.
1. "Disputing Errors on Credit Reports" . Consumer.FTC.gov