Buying a Home With Less Than Perfect Credit: It Can Be Done!
By Scott Hudspeth, Mortgage Specialist
Don’t be discouraged—if your credit is not the greatest, you still can probably get financing to purchase a home. In this market especially, sellers and mortgage lenders are not as stringent as you might think.
Step One: Check your Credit Report
Get your current credit reports from the three nationwide credit bureaus – Experian, Trans Union, and Equifax – plus obtain our FICO (Fair, Isaac and Co.) scores from these three credit bureaus. Most mortgage lenders obtain a 3-in-1 combined credit report on prospective borrowers so I checked all three of my credit reports.
You’ll notice that each credit bureau will have different information and a different FICO score. That’s because not all creditors-credit card companies, department stores, banks, etc.—report to each bureau. FICO scores from the three major credit bureaus can vary quite a bit.
FICO says consumers in the highest score range of 750-799 have a delinquency rate of 2%. But FICO scores below 500 have an 83% default rate, 500-529 shows a 72% delinquency rate, in the 550-599 range there is a 52% probability of delinquency, 600-649 scores show a 31% delinquency rate, and 650-699 have a 15% delinquency rate. Over 700 the delinquency rate drops to 5% up to 749. If your FICO score is 800 or over, you have a 1% delinquency likelihood.
Most mortgage lenders consider a FICO score above 680 will entitle you to the lowest interest rate. The www.MyFICO.com website provides lots of valuable insights on how to improve your FICO score.
Your credit score will be the number by which you are measured in many capacities as you seek credit from anywhere. But the criteria each creditor uses when deciding whether to extend credit, and how much credit to extend, varies widely. Some creditors won’t extend credit to anyone with a bankruptcy over the last 10 years. Others will extend credit if it has been discharged for a certain period of time.
What does FICO measure? The length of your credit history, on-time payments (even one late payment beyond 30 days hurts FICO scores), number of credit accounts, percentage of balances to available credit, collections, derogatory public records (such as judgments and unpaid property taxes), and number of recent credit inquiries with the past six months.
Get your 3-in-1 credit report before applying for any type of credit. Don’t worry-your purchase of your own credit report does not show up an inquiry on your report. Go to www.myfico.com for this report. The fee is nominal. If you find mistakes which are hurting your FICO score, each credit bureau includes either an online, telephone, or mail procedure to correct the errors. After you register an error, by federal law each credit bureau has 30 days to either verify their information is correct or remove unverified information. Ask for a free corrected copy of your credit report after the error is removed.
Building or Repairing your Credit
Avoid the “credit repair” firms that are advertised everywhere—they are scams. You may be able to find a consumer credit counseling agency, which shouldn’t charge a whole lot to help you clean up your credit.
If you have no credit, start building. The easiest places to get credit cards if you have no credit file are usually gasoline companies and department stores. If you buy a car, finance it – but be sure there is no prepayment penalty if you want to pay off the car loan in a few months – and be sure you finance with a major lender who reports to the credit bureaus.
If you filed bankruptcy, start rebuilding your credit as soon as you are “discharged” from bankruptcy court jurisdiction. If you filed Chapter 7 bankruptcy and were discharged from all or most of your debts (except secured debts, such as a real estate mortgage), be sure to pay all your obligations on time from now on. Bankruptcy will remain on your credit report for 10 years. Don’t go this route unless you have no other option. With this on your credit record, you will have a lot of trouble getting credit down the road.
That’s not to say you won’t get credit again. Some lenders will approve you for a mortgage only a year after discharge. However, your interest rate may be high.
Why Mortgage Applicants are Declined:
- no credit file (usually because the applicant pays cash and has little or no established credit)
- insufficient information in the applicant’s credit file
- insufficient income
- short time on the job – at least two years in the same field are usually required by most lenders
- slow pay and/or poor credit history indicated by a low FICO score
- judgments, garnishments, liens, or past bankruptcy
- accounts sent to collection agencies
- current bankruptcy which is not discharged
- foreclosure
- repossession (usually an automobile or furniture)
No credit or insufficient credit can often be overcome, such as by showing timely payment of rent and utilities. But the other reasons for “decline” are usually more difficult.
There are lenders who will risk lending to people with these credit problems, but the interest rate may be brutal.
Co-signing or Guaranteeing
My hard and fast rule is: never co-sign or guarantee another person’s credit. All the credit obligations co-signed or guaranteed by you will appear on your credit reports. If the primary obligor fails to pay, or pays late, the non-payment or late payment will show up on your credit reports and your credit rating will be adversely affected. You will also be expected to pay if the primary debtor doesn’t pay! Even if you pay, but the payment is late, your FICO score will be damaged.
Pre-Approval
First, get pre-approved in writing for a home loan. IF your FICO score is over 600, and you have adequate income, you probably can secure a mortgage. The easiest loans to get are FHA and VA home loans. Lenders will evaluate your income and whether the monthly housing payment will take more than 29 to 33 percent of your monthly household income. There is a lot of latitude here—I have seen home loans approved when the house payment will eat up 40 to 50 percent of a borrowers monthly income. But that has been in cases where the borrower had a high FICO score, stable income and little or no other debt and substantial amount of reserves.
So go ahead and get pre-approved from the mortgage lender that you decide upon. There shouldn’t be a fee for this. But, keep in mind that pre-qualification is not the same as pre-approval. Pre-qualification is essentially worthless. It just means that the lender thinks you may qualify for the loan. A pre-approval letter is issued after the lender evaluates the written loan application and verifies all of the information.
Types of Lenders
Mortgage brokers work with the borrower and the lender to broker the best loan. The big advantage offered by mortgage brokers is they have contacts with dozens, sometimes hundreds, of out-of-area lenders so they can match you with the best lender for your situation. If you have credit problems, a mortgage broker might be the best option to obtain a lender’s pre-approval letter. Make sure your pre-approval letter has a specific expiration date, and ask about locking in an interest rate. Also, make sure that you get, in writing, the broker’s loan fees.
Mortgage brokers may have contacts with wealthy individual lenders who loan mortgage money without checking the borrower’s credit or income. This comes with a high price, of course. If you only need mortgage money for a short time, such as one to five years, these mortgage brokers who don’t ask many questions can be worthwhile.
Banks, credit unions, and savings banks are direct lenders of their own funds. You will be working directly with the lender instead of a middleman. Keep in mind that loan officers are often paid commission. Another disadvantage is that these lenders have limited loan programs, and may not be able to help someone with credit problems.
Mortgage bankers loan their own funds but quickly sell the new loans in the secondary mortgage market. Major mortgage lenders such as Countrywide, Home Side Lending, and Wells Fargo Mortgage are mortgage bankers who originate home loans with their own funds and then quickly sell them into the secondary mortgage market.
Carry-Back Mortgages
You might be better off buying a home whose seller will “carry back” the mortgage financing for you. With seller financing, there is no loan application, no credit check, no long wait for mortgage approval by unreasonable lenders, no appraisal, no extra loan costs, and the buyer gets to specify the mortgage terms you want (such as 6% interest, 30-year mortgage term, etc.) in your purchase offer for the home. If the home seller doesn’t like the seller carry-back mortgage terms you offered, the seller can counteroffer with acceptable terms which you can then either accept or decline.
The best candidates for seller financing are homes:
- on the market for at least 60 days
- that are vacant
- paid for free and clear
- owned by people who don’t need immediate cash (such as retirees)
Assume an Existing Mortgage
This is similar to seller financing, when you take over an existing mortgage from the current owner. There are a couple of ways to do this:
- Purchase the home “subject to” its existing mortgage. This method works especially well with a highly-motivated seller who doesn’t have much equity in the home. “As the buyer, this method has virtually no risk for you. However, as explained earlier, there is a risk for the seller because, if the buyer defaults, that default shows up on the seller’s credit report but not on the buyer’s credit report. Like seller financing, no credit check is usually required.
- Formally assume the existing mortgage. The other method of taking over an existing mortgage is to assume its legal obligation. Home sellers should insist on being released by the lender from further liability after the buyer assumes the existing mortgage. But that’s the home seller’s problem, not yours.
Lease-Option
If you have poor credit and plan to own the homes for a short time, consider a lease-option to purchase.
For More Information about Lease Option (Rent to Own) go to www.kalamazoorenttoown.com
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