So you made a few (or many) financial mistakes in the past, and your credit is not so good – aka it’s really bad – what can you do? Is there any hope of home ownership or are you doomed to a lifetime of renting?
The good news for you is there are home loan options available to borrowers with less than stellar credit scores. These types of mortgages are called sub-prime mortgages, and they are designed to offset the increased financial risk of these borrowers by significantly higher interest rates. Lenders use a number of different factors to determine the interest rates and terms of these sub-prime mortgages. Factors that the lenders also look at in the credit history of these borrowers are the type of delinquent payments they’ve had. For example, if they’ve made late payments on previous mortgages, these are considered more damaging than late credit card payments.
The terms of these sub-prime loans can also be quite strict. Sometimes the sub-prime home loan is coupled with a balloon loan and the borrower must pay off the entire amount of the loan at the end of a given time period – perhaps five years. They may or may not have the ability to refinance the sub-prime mortgage, and the borrower would lose possession of the home.
Other factors that influence the terms of the lease are late payments, non-payments, amount of existing debt, types of credit accounts, credit history length, credit report inquiries (hard check), history of applying for credit, and generally bad credit behavior like fraud.
Borrowers are encouraged to review their credit reports and clear up any existing errors or problems that are negatively impacting their credit scores. Identity theft is a new reality and a very real possibility, so making sure there are no surprises will help ensure you get approved for a sub-prime mortgage.
The Federal Housing Administration loan is an alternative sub-prime mortgage option intended to give people with bad credit another shot at home ownership. The loan terms are very liberal and often have an interest rate of 3% and a small deposit.
The other type of home loan option is called a 2/28 ARM. This offers an attractive interest rate for 2 years and then sharply increases the interest rate for the remainder of the loan. The intended purpose of these loans is to give the borrower the opportunity to improve their credit score and be able to refinance the loan and get a lower interest rate. If the market suddenly changes, then it’s possible that refinancing won’t be an option. In many situations, the inability to refinance would mean the loss of the home.
You will have to explore the sub-prime options if you have a credit score lower than 620, 2+ days’ delinquencies of 30 days on a mortgage in the past 12 months, 1 delinquency of 60 days on a mortgage in the past 12 months, a charge-off or foreclosure within the past 24 months, bankruptcy within the past 24 months, debt to income ratio of over 50% and inability to cover family living expenses in the course of a month.
Keep in mind that your credit scores do not solely determine your creditworthiness. If you’ve had a few bad days, you don’t need to jump to conclusions and assume you won’t qualify. The only way to know is to apply for a home loan and give the lender the opportunity to review your financial history.
For borrowers with bad credit, there is, in fact, hope for you. The sub-prime mortgage options have more difficult terms and higher interest rates, but there are pathways to home ownership available to those who have made some mistakes.
Finally, if you have sufficient time before you apply for your home loan, you might be able to boost your credit score by trying a few of these tips. First, always pay your bills on time. Rent and mortgages are very important. If you have a credit score of 700, for example, you can bump that up by 20 points just by paying all your bills on time for one month. The next tip is to reduce the number of credit cards you have open – only open credit cards that you absolutely need and keep the balance of those accounts as low as possible. Remember that any credit card you apply for, even if you never use it, will negatively impact your credit score, so make sure not to apply for credit if you don’t absolutely need to. New credit card accounts can lower your credit score by as much as 10 points in some cases. And lastly, your payment trends for mortgages and rent are always tracked and analyzed, so be sure always to pay these on time because they are the most important element for qualifying for a home loan.
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