- Bad credit can mean a bad credit score, low DTI, or a bad mark on your credit score.
- Prepare yourself by repairing and improving your credit.
- Learn about mortgage loan alternatives, like FHA loans or HARP loans.
Looking for a Mortgage Loan and Bad Credit Weighing You Down?
No matter why you take out a mortgage loan, bad credit will weigh you down. You mortgage loan applications may be denied, or approved with a high interest rate and high fees.
For many, a home purchase and a mortgage loan are the biggest financial transactions. Prepare yourself and avoid taking a mortgage loan with bad credit. If you don’t have a choice learn about your alternatives to deal with bad credit mortgage loans.
Make the right decisions about mortgage loans and bad credit by learning about:
- The different types of mortgage loans
- The components that make up Bad Credit
- Your alternatives for bad credit mortgage loans?
Types of Mortgage Loans
Mortgage loans is a generic term applying to different types of loans and credit that is secured by using a house or property as collateral. (Most mortgage loans include a personal guarantee in addition to the property).
Some of the common names are purchase mortgage loan, refinance mortgage loan, HEL (Home Equity Loan), HELOC (Home Equity Line of Credit), or second mortgage.
You make take a mortgage loan for any of the following reasons:
- Purchase a house
- Term and rate refinance
- Cash-out refinance to improve the property, buy a big-ticket item, or pay back unsecured debts such as credit card, medical, or personal loans.
No matter the reason, bad credit increases the difficulty to obtain a mortgage loan. Lenders look for the property as underlying security, but rely on you to repay the loan.
The lender wants to know that you have the means to pay back the loan and the willingness to follow through with the payments. Mortgage lenders follow underwriting criteria to determine if you qualify for a mortgage loan. These guidelines vary by mortgage product, lender, geographical area, and other factors. In almost all cases, bad credit is a barrier to a mortgage loan.
Credit is measured in different ways, but a lender will look at these three main criteria:
DTI (Debt-to-income) ratio: Mortgage lenders know, by experience, that you can only afford to use so much of your monthly income to pay off your housing expenses, as well as you total debt. The front-end DTI measures your total housing expenses, either your rent or your mortgage payment and other insurance and tax payments relating to your house, as a percentage of your monthly income. Your back-end DTI (often referred to just as the DTI ratio) measures your total housing expenses plus your other monthly debt payments (including your minimum credit card, auto loan or leasing, medical debt, student loan) as a percentage of your monthly income.
Although the required DTI ratios vary, a general rule-of-thumb for conventional loans is that your back-end or total DTI ratio should not exceed 45%. A high DTI ratio is considered bad credit. Sometimes, compensating factors, such as a large unencumbered asset, can help you overcome this problem. Use Bills.com DTI calculator to help you determine your ratios. But remember, calculating your exact income and expenses is complicated, so be prepared to work closely with your lender.
Credit Score: Your credit score is the most common method of classifying you as having excellent, good, fair, or bad credit. The most common credit score used is the FICO score, which runs between 350 and 800. Your credit score is based on your past credit history. Derogatory or negative items remain on your report for at least 7 years. Your credit score is determined by:
- Payment History: The single most important factor is timely payments. Late payments, collection items or public judgments will seriously harm your credit score.
- Credit Utilization: You will be penalized anytime you utilize your available credit over about 35%.
- Credit Mix: To improve your FICO score make sure that you have different types of loans, such as auto loan, student loans, credit cards and mortgages. Credit scores vary between overtime and as reported by the different credit reporting agencies, including the big three Experian, TransUnion, and Equifax.
- Credit History: As noted, your credit history affects your credit score. In addition, lenders may deny you a mortgage loan if you have late payments, collection, public judgment, bankruptcy, short sale or foreclosure. Once again, underwriting rules are complicated and vary by program and lender. For example, Fannie Mae requires a two-year waiting period after a Chapter 13 bankruptcy discharge (and 4 years from a dismissal).
As you can see, bad credit comes in different forms. Learn ways to deal with your bad credit.
Alternatives for Bad Credit Mortgage Loans
Since the housing and economic crisis of 2008, the subprime market, which catered to bad credit mortgage loans, collapsed. In fact, taking a loan with bad credit is not only harmful to the lender. Borrowers, who take on too much debt, put themselves in a precarious position. Eventually the debt burden becomes too heavy and you find yourself juggling too many bills.
Here are steps to take when you have bad credit and want a mortgage loan:
Prepare yourself: Make a personal budget. Keep track of your monthly expenses by category. It takes time and patience, but good financial planning helps you control your expenses. Use the Bills.com personal budget guide to get you started. To maintain or build good credit make your payments on time. Use the Bills.com mortgage affordability calculator to help determine what amount of mortgage loan you can afford.
Repair: Monitor your credit report. Dispute any negative item that does not belong to you. If you have collection items that negotiate a pay for delete settlement, or at least a settlement to have them marked as paid off. If you are considering professional help, then read the Bills.com review of Lexington Law Review.
Limited Products: There are some mortgage loans for bad credit, although significantly less than before. Here are some examples:
- Subprime loans, offered at high interest rates and high fees. As the housing market stabilizes, some lenders have reentered the subprime market. For self-employed borrowers who have a good credit score, but bad credit due to their weak DTI ratio, often due to strict underwriting guidelines regarding their verifiable income, subprime loans is their only alternative.
- FHA Loans: FHA loans are popular alternatives bad-credit mortgage loan alternatives. A FHA purchase loan has lower credit score requirements. As of April 2012, the minimum requirement is 580 (although a lender may require a higher score). The FHA also has a streamline refinance loan with no appraisal and less restrictive credit requirements.
- HARP Mortgage: The HARP mortgage program requires a near perfect payment record on your mortgage payments over the last 12 months. A manual refinance, which you can do through your original lender/current servicer, does not require a DTI ratio check, minimum credit score, or waiting periods after a bankruptcy. The automated system, which is available through all participating lenders, requires a minimum credit score of 620 and DTI ratio of about 45%. However, your loan must be a Fannie Mae or Freddie Mac loan, delivered to them before June 1 2009.
Steps to take for Bad Credit Mortgage Loans
If you don’t have a mortgage and you have bad credit then:
- Make a budget
- Repair your credit
- Build your down payment and rainy day reserves.
- Look into a FHA loan.
If you have a mortgage and bad credit but can afford to make your payments, then look into:
- Streamline refinance for a FHA loan.
- HARP mortgage for a Fannie Mae or Freddie Mac loan.
- If you have a mortgage and cannot afford to make the payments then contact your lender about a loan modification, including the HAMP program, of a short sale, including the HAFA program.