I Have Bad Credit. Is Home Ownership Possible?

By Gina Pogol
Mortgage Credit Problems Columnist

Lorraine Asks: Dear Gina, I recently went throrugh a divorce and ended up with bad credit because of it. I'd really like to buy a home now because I qualify to get the first time buyer credit, and because there are very good deals out there. Is financing available?

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Gina Says:

Dear Lorraine,

Thanks for writing. Credit problems after a divorce are not unusual. Whether you can or should by a house with a subprime or bad credit home loan depends on a few things.

How Was Your Credit Before Your Divorce?

If you had good credit before your divorce and managed your finances effectively, you may be able to get an FHA loan. Or at least it's likely that you can clean up your act and refinance out of a bad credit mortgage fairly quickly. If your credit wasn't that great before your divorce, or if your ex managed the money, you might want to get some credit counseling before buying a home. Bad credit mortgages should never be long-term solutions--plan to fix your credit and refinance to an FHA or conventional mortgage as soon as you can.

Do You Have a Substantial Down Payment?

The days of 100% financing are over--especially for people with credit problems. Bad credit lenders want to see a substantial investment on your part if they're going to risk lending to you. Plan on putting down at least 20%, and know that you may be asked to come up with even more.

Do You Have a Healthy Income, and Can You Prove It?

The days of stated income or "liars' loans" are over too. Subprime mortgage financing comes at a price--an interest rate that may be twice what financially flawless applicants pay. So you have to earn a lot more than the guy next door to qualify for the same size mortgage. Contact some lenders and see what interest rates they have to offer. Then, plug the numbers into a mortgage calculator and see how much you can afford.

Do You Have a Bankruptcy or Foreclosure on Your Record?

If either of these events is recent (less than two years for a bankruptcy or three for a foreclosure) you have to go with a bad credit lender. If not, you may be able to qualify for FHA financing. If your credit history before the divorce was good, and you can show that your spell of bad credit was not your fault or under your control, and (here's the biggie!) you can show that you have gotten past the problem and resumed paying your bills on time, FHA underwriters may give you a break. Here's what the guidelines say:

"A borrower who has made payments on previous and current obligations in a timely manner represents reduced risk. Conversely, if the credit history, despite adequate income to support obligations, reflects continuous slow payments, judgments, and delinquent accounts, strong compensating factors will be necessary to approve the loan."

You should probably try to get approved for an FHA loan before you opt for a bad credit mortgage. If you have a large enough down payment and earn enough money, you may be approved even with some ugly stuff on your credit history. You have nothing to lose by trying.

Have You Defaulted on Federal Debt?

If you defaulted on a student loan, government-backed mortgage, or tax obligation, you probably won't be able to get an FHA mortgage, even if you have good credit. You have to resolve the problem first and clear your name. Or get a bad credit mortgage.

Is Your Home Too Expensive to Finance it with FHA?

If you're buying a high-end home, FHA won't insure it. You have to either fix your bad credit and apply for a larger loan or get a subprime mortgage.

Is There a Compelling Reason to Buy Now Instead of Later?

It's a lot cheaper to buy when you can get a prime interest rate. The only reason to purchase a home with a bad credit mortgage is that you expect it to cost more later. If you found a screaming bargain and need to close it now, or if you are worried about interest rates and home prices increasing before you can get your credit cleaned up, and if (another big if!) you can easily afford the higher interest rate and payments, then by all means apply for a subprime home loan.

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