What's the Truth about Bad Credit Mortgage Lending?
Here's a taste of what elected officials and the media are saying in the wake of the mortgage crisis, which first became apparent when sub-prime loans began to go bad: "Sub-prime or bad credit mortgages are evil!" "Borrowers were unable to understand (read: too stupid to figure out) what they were signing." "Home buyers were given attractive rates and then after 2 or 3 years the horrible lenders pulled the rug out from under them." "This must be stopped!"
Consider the Purpose of a Bad Credit Mortgage
Okay, so what are our leaders really saying? That it was BAD for lenders to give a decent starting interest rate to borrowers with credit blemishes? Think about it. Borrowers had two to three YEARS to clean up their credit and refinance before their rates increased. And if they didn't do it with that much time (you can get an FHA loan 2 years after a bankruptcy or 3 years after a foreclosure if you can show that you've cleaned up your act) then it seems a bit unfair to blame the lender who did after all give these buyers a chance. Subprime loans aren't meant to be a way of life; they are supposed to be a way to rebuild credit and get a home while doing it. By taking these loans away, our legislators make it harder for those who are motivated to turn their credit history around and make a housing investment to do so. And most of the people with those loans did successfully pay them -- why hurt those who are after all in the majority?
It's also unfair to the rest of sub-prime, bad credit, or Alt-A borrowers to say that the government has to protect them from themselves. Kind of insulting, like if you had a financial setback it must mean that you're stupid, greedy, or lazy. But now the government wants to add even more pages to your loan packages. Not a problem except that it increases paperwork and expense in an already burdensome process.
Make a Sub-prime or Bad Credit Mortgage Work for You
You probably don't need your hand held while getting a sub-prime mortgage. However, by following these guidelines you may be able to take advantage of a great real estate investment while prices are lower:
1. Work with a federally regulated lender. One big problem associated with bad credit mortgages is that about half of the lenders aren't subject to federal regulation or scrutiny. A reputable lender is your first defense against being ripped off.
2. Shop for your mortgage and read your documents thoroughly. Make sure that if you have a prepayment penalty it isn't longer than the fixed rate period of your loan -- you don't want to be stuck with a high rate when your loan begins adjusting. By checking with several lenders you can be more certain of getting a fair deal because subprime loans are underwritten and priced differently from traditional mortgages. It pays to have a number of lenders look at your application and see what they can come up with.
3. Use your time wisely. If you have two years to clean up your credit before a rate increase make sure you start immediately. Pay your bills on time, close any open collections, and take care of judgments or tax liens. If you don't have the discipline and the means to get this done then home ownership is probably not a good idea for you yet.
4. Try FHA first. If you are borderline-bad you might be able to squeak into an FHA program. Even if you can't, get the guidelines for approval so you know what you will have to do to be approved when you are able to refinance out of your bad credit home loan.
5. Ask for advice. That's what this blog is for -- we're here to help you with your bad credit mortgage questions.
10 Responses to "Time Is Money and Information Is Power-- Use Yours Wisely"
It depends on what you call 'bad credit.' Many bond program underwriting guidelines are similar to those of FHA. Until recently, FHA didn't even have a minimum credit score requirement. Now it's 580 which is pretty low by most standards. FHA also uses a matrix to judge the overall strength of an application. Deal killers include foreclosures within the last three years, bankruptcies within 2 years, or multiple late payments on mortgages in the last year. Normally an application is underwritten by an automated system but if it gets kicked out ("referred")a human underwriter will look at it and weigh all the factors involved.
The best thing you can do to help your case is to make your payments on time now, and clear any collections, judgments, etc. Underwriters look far more favorably on applicants who can show that while they had some issues in the past they have cleaned up their acts. A continued pattern of delinquency won't help you get approved.
Second, these loans require verification of income, and your income needs to be sufficient to make your payments and your mortgage. In general, your new house payment shouldn't exceed your current housing expense by much unless you have also managed to save a lot of money. Otherwise, an underwriter will think that if you could barely pay your bills when you had a low rent payment how could you possibly make a higher mortgage payment with the same income? So if your credit is marginal, your income and assets become a lot more important.
I've heard a lot about these bond programs that help new buyers with their down payments. Can someone with bad credit qualify for this type of a program?
True. I also find this happens a lot when students living at home buy a car with a really high payment. They graduate, get a job, and want to buy a house -- but that $850 a month truck payment is a booger. Consolidating student loans is one possible option, but keep in mind that loans that lower your payment by stretching out the repayment period will result in you paying more interest over the life of the loan. I recommend that you continue to live like a poor student a little longer and get yourself in a stronger financial position before taking on home ownership. Look at what you'd be paying if you bought a home in your neighborhood, take the difference between that and your current rent, and save that each month. It will get you used to paying the extra (and seeing if that's something you want to do every month) while helping you save a bigger down payment or pay down bills. Starting out smart can help you avoid a lifetime of bad credit mortgages or subprime financing.
I was recently told the same thing. I think it is because I have so many student loans to pay off. I would imagine this doesn't look good when applying for a home loan as it could be evidence that you may not be able to afford a house payment. Am I right?
If your debt to income ratio (debts including mortgage, property taxes, homeowners' insurance, and your other monthly obligations divided by gross income) is too high to get a credit card it's probably too high to get a house. Unless your rent is very expensive and buying a home would lower your housing expense. For a good credit, grade-A mortgage you should ideally have a debt to income ratio of no more than 33% although a substantial down payment and excellent credit could secure you an approval with a ratio as high as 45%.
Recently I applied for a credit card through my bank and was told that my debt to income ratio was too high. I want to get preapproved for a home loan. Do you think that this will inhibit me from getting a home loan? What options might I look into?
Not all lenders offer these programs and so they might try to steer you to whatever programs they do offer. Online shopping is a great way to get to those who offer the programs you are interested in. Work with one that has the programs and does a lot of those loans - they can be complicated. Another option is to contact your state or local agencies about community homebuyer programs, USDA loans (in rural areas), down payment assistance or Nehemiah Program® and see if they can point you to a reputable lender.
What if the lender who you're working with won't give you information on state programs for first time home buyers? I keep hearing that lenders don't want to give out this information. What can FTHB do to make sure they know about all the programs available?
Many people don't know this (including some loan officers) but your loan officer can and should be able to help you compile a credit history. Get your utility bills, cable, cell phone, and landlord information together and the lender should be able to have a credit agency verify this information and compile a report. If you have time to work with consider having a relative with good credit add you as an authorized user on a couple of credit cards -- their payment history for those cards will eventually appear on your report and influence your score. These days with automated underwriting the lack of a credit score makes it harder than in the past to get a mortgage but you could probably qualify for an FHA loan. FHA now requires a 580 credit score but makes an exception for those with insufficient history to generate a score.
What advice would you give someone with very little credit who is trying to buy a house? I have a good job and the money for a decent down payment, but I have never really built up my credit. Should I do so before looking to buy? Thanks.