My Credit is Bad, Can I Still Get a Mortgage?

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People with less than perfect credit who want to buy a home usually fear that they won’t be able to get a mortgage at a reasonable rate or at all. Granted, it can be harder to qualify when your credit rating is low, but consumers do have some options.

One of the first things to do is get a copy of your credit report and score.  You are entitled to one free credit report from each of the three major credit bureaus each year by law (in some states, you are entitled to more than one free report a year).  You can get your free credit reports from www.annualcreditreport.com.  However, you are not entitled to free credit scores.    

You must pay for your FICO credit score, the score practically every lender uses, from myfico.com or one of the credit bureaus (Experian, TransUnion or Equifax), usually for about $20 per score.  You can also obtain a free approximation of your FICO score from CreditKarma, which provides a “TransRisk New Account Score,” VantageScore, and Auto Insurance Score — all supplied by TransUnion. Or you can use CreditSesame to estimate your FICO score, which provides you with Experian’s National Equivalency Score at no charge.   If you order your credit score from anyone other than myfico.com, you will only receive one of the substitute scores mentioned above — and not your actual FICO score.  Since most mortgage lenders use the FICO score, getting a different (but often free) score might not provide you with a true picture of where you’re at score-wise.

In case you don’t know what the numbers in a credit score mean, here’s a quick rundown: a score of anything below 620 ranks as poor; 620-699 is fair; 700-749 is good, and anything over 750 is excellent.

Once you have your score, you can consider your options.

Conventional Loan Products

A conventional loan offers the lowest interest and the best terms, but also has the strictest credit criteria. The cutoff for getting a conventional through a FNMA (Fannie Mae) or FHLMC (Freddie Mac) program is technically 650 points, but you will be hard pressed to find a lender who will go that low. The criterion used by banks for mortgage lending has only recently lessened since being tightened up significantly after the bank crisis of 2007, however, even with looser standards, most banks will not lend to those with credit scores below 680.  The lower the score, the larger your down payment will be.

Fannie and Freddie guidelines say you can do a conventional loan 4 years after a bankruptcy, but you still must have a qualifying score.  In addition, you will have to provide much more documentation to show you’re now a good credit risk.  Some banks are also loosening standards to allow lending to people with short sales or foreclosures.

Conventional loans also have the tightest debt-to-income ratio requirements: typically the limit is 36% of your gross income can be used to pay off revolving and installment monthly debt bills.  You need to put at least 5% down to get a conventional loan, but if you put down less than 20%, you will be required to buy mortgage insurance.  Mortgage insurance can raise your mortgage payments by $100 or more.

FHA Loans

If your credit score falls below 650, you might want to try the Federal Housing Authority (FHA)’s loan program.  The FHA will insure your loan against possible default, as long as you can put up a minimum of 3.5% of the down payment.  The rule book says you must have a score of 580 or higher to get an FHA loan, but due to the tight lending environment, no lenders will likely go below a 620 score with a 3.5% down payment.  You might be able to get qualified at a lower score if you put down more money – say 10%.

It’s not only your credit score that makes you eligible for an FHA loan.  You’ll also need to supply proof of income to calculate your debt-to-income ratio. FHA wants to make sure that 41% to 43% of your monthly gross income can be applied to making the minimum payments on all of your monthly debts, including revolving charges and installment loans.

Since the housing crisis and ongoing financial recession has hurt so many people, FHA offers a loan program that actually takes into consideration your individual situation. If your lousy credit is due to circumstances beyond your control, and not ineptitude at managing your money, the FHA offers its “Back to Work” program. This enables consumers who are simply the victims of bad luck to become eligible for a loan after a term of unemployment or under-employment which limited their income.

FHA loans are not without some drawbacks. Like conventional mortgages, with such a small down payment, you must pay for mortgage insurance during the term of the loan. Rates for FHA loans are slightly higher than conventional mortgages.

VA Loans

If you were active military in the Reserves or National Guard, you should qualify for this program. The VA itself does not have any credit criteria, however, as with other programs, banks will not usually loan to anyone with less than a 620 score.  In addition to the advantage of lower credit standards, the bank will do a loan for 103.3% of the value of the home.  Though highly leveraged, VA loans do not require mortgage insurance – another advantage.

The department of Veteran’s Affairs will insure loans up to $417,000 (higher in some areas of the country) and does have some restrictions on the types of properties approved (in general, extreme fixer-uppers will not qualify).

Owner Carryback

In this situation, the seller acts as the lender, and the buyer makes payments directly to the seller, plus monthly payments that accrue towards a down payment without involving a bank. Typically with an Owner Carryback, the seller will carry the mortgage for a set period, say five years or so, and then the buyer must be prepared to either make a balloon payment for the balance of the mortgage, or arrange for a regular mortgage. This might be a good option for people with damaged credit who are working toward re-establishing good credit, since it gives the buyer several years to make payments and establish good credit before applying for a regular mortgage.

Rent-to-Own

Rent-to-Own agreements have some similarities to Owner Carryback as well as some differences. For example, with rent-to-own, your lease includes the price of the home as well as the portion of your rent that goes towards the sales price, and a set term where you can rent before you buy, anywhere from one to five years. This gives you time to rebuild your credit and make payments on the price of the house. Of course, with a rent-to-own agreement, you will also have to come up with a down payment, which will be higher than a typical security deposit. Your monthly payments will be higher than regular rent because you’re also paying part of your deposit each month.

Hard Money

Another alternative available to prospective homebuyers with poor credit is a “Hard Money” loan.  You don’t need any kind of credit at all to qualify, but the lender will be quite choosy about the property.  These loans are not for the faint of heart — you typically need 30-50% down, interest rates are very high, and the loans often come with tough terms like a six-month balloon note.

A hard money mortgage is used more often for house flippers than for people with poor credit, but it’s another alternative.  If you have a large down payment and are working on improving your credit, a hard money loan could serve as a “bridge loan” until you can arrange other financing.  However, you will have to pay a high premium, so it may be better to rent until your credit is back in shape.

Posted in Mortgages
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