Author Archive for Gina Pogol

Why is it so hard to get a home loan if you have bad credit? Blame the government behemoths that control 90 percent of American mortgage financing.

Fannie Mae and Freddie Mac enacted a policy that can force lenders who sell mortgages to them to eat the loans if the borrowers default. Tiny mistakes in loan processing or underwriting can put lenders on the hook, even if the cause of default is completely unrelated to the lender's practices -- for example, a medical catastrophe or job loss on the part of the borrower. That has scared the pants off of many lenders, so now they'll only lend to the lowest-risk applicants.

The exit of all subprime and Alt-A lenders from the market left a huge void in mortgage financing, and it was only a matter of time before someone moved in to exploit that opportunity.

Subprime mortgages are back

Premier Mortgage Lending in Las Vegas, Nev., is offering "Another Chance" home loans for people with bad credit, short sales or foreclosures in their history. Other companies may soon follow.

Another Chance loans carry higher-than-typical mortgage rates (8.99 percent as of this writing) to compensate their investors for the added risk they're taking. Borrowers may close within 30 days of loan approval.

The new breed of bad-credit loans

The new subprime mortgages are not the sort that sucked the life out of America's housing markets a few years ago -- mortgages for people with the triple whammy of bad credit, no down payment and no income. To get one of these new bad-credit mortgages, you'll need at least 20 percent down and enough documented income to afford your mortgage plus other expenses.

Here are some of the key requirements for Another Chance loans, which may reflect what similar mortgages will require:

• History of bankruptcy is acceptable. Chapter 7 bankruptcies must be fully discharged. If you have a Chapter 13 bankruptcy, you must have proof of 12 months of timely payments plus court approval to purchase property.
• History of foreclosure or short sale is acceptable. In fact, borrowers with a foreclosure or short sale are acceptable one day after the transfer of ownership.
• Maximum debt-to-income ratio is 45 percent. You may qualify for a higher debt-to-income ratio if you have a bigger down payment or other compensating factors.
• Reserves for three payments. You must have enough money to make three mortgage payments (principal, interest, taxes and insurance) after closing.
• Documentation of income. You'll need to provide two years of tax returns with W-2s and schedules, plus pay stubs covering the most recent 30 days.

Don't live in Nevada? Don't give up

The most exciting thing about this reentry into subprime lending is that, if successful, Premier's business model may be repeated nationwide. Investors wanting a healthy rate of return may trigger an intelligent return to bad credit or subprime mortgage lending.

If you're about to apply for a home loan and have bad credit, you're probably trying to find ways to raise your credit score before you do. Is there an ideal number of credit cards to maximize your credit score? And is there such a thing as too many credit cards?

A common rule-of-thumb claim is that the ideal number of credit cards ranges from three to eight or more. In reality, the number of credit cards you have is less important than the age of your accounts, your payment history and the amount of debt you carry.

Reason codes and your credit history

FICO credit reports -- FICO being the creator of the most widely used credit scoring system in the U.S. -- contain "reason" or "adverse action" codes that explain why your credit score was lower than the best possible. There are many, many reason codes, and the top four negative factors influencing your score are listed. Here are several:

• Amount on recently opened accounts is too high
• Lack of recently established accounts
• No recent balances
• Length of time accounts have been established is short
• Time since account activity is too long
• Time since account established too short
• Proportion of balances to limit is too high

Codes for "too many accounts" have been abandoned and are no longer in use. One could probably assume from that that having "too many accounts" is no longer a significant factor in determining your credit score.

What's in your wallet?

Determining the best number of cards for your credit profile involves examining your mix of cards. For example, suppose you have five cards, each with $1,000 limits and a total balance of $2,500, on average ten years old. Should you close a couple of cards? Should you open a couple of new accounts? Consider:

• Closing a newer account could increase the average age of your open accounts, which should improve your score.
• However, closing accounts without paying off any of your balances would increase the percentage of available credit used (i.e., increase your credit utilization). While $2,500 of $5,000 total available credit is only 50 percent, $2,500 of $4,000 is 62.5 percent. This could drop your score.
• Opening up a new account has the opposite effect. On one hand, adding available credit without adding to your balance gives you a better ratio of balances to available credit. However, new cards mean a shorter average account age, and a newly established account nearly always causes your score to drop in the short term.

Time off for good behavior

One thing the codes make obvious is that credit is like muscles -- you need to use it or you lose it. FICO likes to see you using your accounts and paying them on time. If you've been good about this, you may be able to get an increase in your credit lines without opening up new accounts. That improves your profile without the credit score dings.

Debt consolidation through a refinanced home loan can offer a tempting promise -- the exchange of your maxed-out credit cards for a clean slate. The trouble is, consolidating debt with a refinance doesn't reduce it by a cent. It just moves your balances to your mortgage lender.

Industry experts put the failure rate of debt consolidation programs as high as 80 percent. If you're part of the four out of five who take out these loans and don't pay them off, you could be worse off. The better you understand debt consolidation -- what it can do and what it can't do -- the less likely you'll make a bad financial move.

Understanding debt consolidation home loans

The critical thing to understand about consolidating your credit card debt with your home mortgage is that doing so extends the repayment period, which can greatly increase your overall interest paid. So a debt consolidation refinance could cost you a lot more, even if your interest rate is much lower.

Try this exercise with an online mortgage calculator and you'll see:

• If you have $10,000 of credit card debt at an interest rate of 15 percent annual percentage rate (APR), a typical payment of 3 percent of your balance equals $300. It would take you almost 18 years to pay it off and cost you $6,937 in interest.
• Let's say you take out a cash-out refinance at 5.5 percent to pay off your cards. The lower rate drops your monthly payment to $57, but you're spreading out your payments over years -- which increases your total interest cost to $10,440!

Of course, if you pay the same amount each month to aggressively chip away at your principal, the lower home loan rate will save you a bundle. But if you don't direct extra money toward your debt repayment, you'll pay more in the long run.

The best of intentions

I can hear it now: "Gina, if I consolidate my debt, I'll just pay it off faster! Then I will save money!" OK, I believe that you fully intend to do this. But people with credit problems may not be in the habit of denying themselves goodies. Know your own weaknesses: If not constrained by the terms of your loan, will you really make that extra payment, month after month, and not use your credit cards to buy things you don't earn enough to afford?

Give debt a one-two punch

Debt consolidation can work, of course, but it needs to be part of a total financial plan. Here's an example of how you might handle balances like the one above:

• Consolidate your credit card debt with a cash-out refinance at 5.5 percent.
• Instead of your old payment of $300, your new payment is $57. Put $100 a month into savings for emergencies (or a celebratory splurge… when you are debt-free, that is), then pay an extra $143 a month to pay interest and reduce the principal on your new mortgage.
• If spendthrift ways are at the root of your debt problem, close out your credit cards, keeping one for emergencies and for transactions that are very inconvenient without one (such as hotel reservations and car rentals). Don't carry the credit card with you if you're prone to impulse buys; use cash or a debit card instead.

If you follow this plan, guess what? Your $10,000 in credit card debt is paid off in four years and nine months, and you pay only $1,386 interest. Now that's a smart solution.

For poor credit mortgage borrowers, the Federal Housing Administration (FHA) offers government-backed loans that are often a better deal than non-government loans. That's why it was news when, in October 2011, temporary loan size increases -- authorized by Congress in 2008 to help relieve the effects of the housing crisis -- expired.

For a while, these "jumbo conforming" mortgage limits, which raised the FHA loan limits to $729,750 in some areas, went away. Prospective borrowers in high-cost areas were particularly out of luck, because lenders impose stricter guidelines for jumbo mortgage approvals. Provisions of the Housing and Recovery Act dropped loan limits to 15 percent more than median home prices -- capped at $625,500 rather than $729,750 for high-cost areas.

However, in November, Congress raised the FHA loan limits, restoring them to their recent, higher levels. The increased mortgage limits are in effect until 2013. This step makes it easier for those who need the flexibility of FHA's underwriting to get approved for a new home loan or mortgage refinance.

If you already have an FHA loan, the new limits mean you may be eligible for streamline refinancing at higher limits. Underwater homeowners with FHA mortgages can refinance with no credit check. You may not even need an appraisal.

The FHA loan advantage

To see why having FHA loans as an alternative is advantageous, take a look at some typical jumbo mortgage guidelines. Here's what you're up against if you try to buy or refinance in an expensive area like San Francisco, Calif., or Arlington, Va.

• You must have a 20 percent down payment or 20 percent home equity, because mortgage insurers won't insure jumbo mortgages.
• Those with less than 35 percent home equity or down payment need a 720 minimum FICO score, and everyone else needs at least 680 to qualify.
• Investment properties not eligible.
• The maximum debt-to-income ratio is 45 percent.
• A second home purchase requires a 35 percent down payment.
• Declining markets reduce loan-to-value by an additional 5 percent in Arizona, California, D.C., Florida, Michigan and Nevada.

Qualifying for an FHA loan

FHA may allow lower credit scores, but that doesn't mean that people with bad credit automatically get mortgages. Your credit problems must be behind you: You must be paying your bills on time and not accruing any more collection accounts, judgments or other black marks. You must also be able to prove that you have sufficient income and stable employment.

However, if you have truly overcome your credit problems, an FHA mortgage could make it easier for you to get into a home of your own -- even in an expensive neighborhood.

If you are managing your debt with credit counseling or a debt management plan, will that count against you in the mortgage qualifying process?

Credit counseling vs. debt management programs

Credit counseling alone -- that is, getting advice on budgeting and creating a plan for debt repayment -- can only have a good effect on your credit. The fact that you are being advised doesn't show up on your credit history, and reducing your credit card balances and paying on time improves your score.

However, some debt help firms put their clients in debt management plans (DMPs). DMPs work like this: You send the company a check each month, and they distribute the payment to all of your credit card companies. Many counselors don't just take your money and pay your creditors. They can arrange lower interest rates, smaller payments and perhaps even a balance reduction.

Debt management programs and your credit score

The fact that you're in a DMP may be reported to credit bureaus. From a credit history perspective, this may be good or it may be bad. Some creditors "re-age" a delinquent account after several successful on-time payments to show it as current on your credit report. Those actions can really help increase your FICO score.

If your debt management company negotiates concessions with your creditors, the way the creditor reports these concessions can lower your credit score.

According to its website, FICO looks at it this way: "Choosing to make partial payments or agreeing to settle for less than the full amount on accounts may be regarded negatively by the FICO® scoring model. Additionally, any late payments occurring either before or after you began the plan may also be regarded negatively."

Creditors may hit your credit history with derogatory codes such as "not paid as agreed" or "account settled for less than amount due." On the other hand, creditors may not report any concessions at all to credit bureaus. And once you have paid off your plan, it drops off your credit history.

Mortgage qualifying and DMPs

Mortgage underwriters have mixed feelings about DMPs. Some take your enrollment as an indication that you have credit problems and are therefore not a good risk. The FHA, for example, considers DMPs equal to Chapter 13 bankruptcies and requires you to have made at least 12 payments into your plan, on time, to become eligible for financing.

Others take the position that enrolling in a DMP is a responsible way to attack credit problems before they get out of control. Enrollment in a DMP may be simply ignored. Fannie Mae doesn't even mention DMPs or credit counseling in their guides.

Given the unknowns whether enrollment in a debt management program will affect your chances of qualifying, ask an experienced loan officer so there are no ugly surprises when you apply for your next mortgage.

Upside-down homeowners with bad credit may be able to refinance to today's rock-bottom mortgage rates, thanks to a relaunched government program known as HARP. Here's what you need to know to apply.

There have been approximately 500 changes to FHA mortgages in the past three years. Lenders that aren't very familiar with FHA loans may make mistakes -- so avoid relying on non-experts for your FHA mortgage.