The End of Subprime Mortgages

Highlights

  • Understand why sub-prime mortgages are so hard to get.
  • Look into FHA loans, if your credit rating is not excellent or if you have little down payment or equity.
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Why an FHA loan may be Ideal for You, if you are a Sub-prime Borrower

If you were looking for a mortgage a few years ago and your credit rating was not good, you would have been steered towards a sub-prime mortgage. You may have also been pushed to a sub-prime mortgage product if you a high debt to income ratio, could not to fully document your income, or had little or no equity in a refinance mortgage and a small down payment for a purchase mortgage

With the collapse of the sub-prime mortgage, lenders have tightened their rule for qualifying for a mortgage. It has become much more difficult to find a lender who will offer you a good loan product if your credit is not strong, you can demonstrate a strong ability to make your mortgage payment, and if your equity position or down payment is less than 10% of your loan balance.

You may need to work on improving your credit score, before any lender is willing to offer you a prime mortgage, but that does not mean that you cannot qualify for a loan with a good interest rate. If your credit rating is an issue, you should look into the FHA (Federal Housing Administration) loan products on the market.

FHA Loans

The FHA does not issue loans. The FHA is part of the U.S. Dept of Housing and Urban Development that insures residential mortgages, but the FHA does not fund the loan for a refinance or purchase mortgage. By guaranteeing the loan, the FHA gives lenders the confidence that the loan will be paid, even if the borrower defaults on the loan. This allows more Americans to qualify to purchase a home and allows mortgage loans backed by the FHA to have lower interest rates.

FHA loans require low down payment

The FHA's guarantee gives borrowers who have less than perfect credit a chance to obtain low interest rate loans. FHA loans also have minimal down payment requirements. A qualifying borrower can finance 97% of the cost of the home, even including the closing costs in the mortgage.

FHA loan income requirements

FHA borrowers must demonstrate an ability to pay the mortgage that they apply for. The FHA requirements protect the borrower from getting a loan that is beyond the borrower’s means. The income requirements are looked at in two ways. The first is to compare the borrower’s gross qualifying income to the new principal and interest mortgage payment, an escrowed portion to cover the property taxes, homeowner's insurance, the mortgage insurance premium, etc. To qualify for the loan, the percentage of these costs cannot exceed 29% of the gross income.

The second ratio compares the borrower’s gross income to not only the costs listed above, but also looks at other monthly payments the borrower has, such as a car payment, a student loan payment, and the monthly minimum payments required by credit card accounts. In order to qualify for the FHA program, these costs cannot exceed 41% of the gross income.

FHA loans and credit

Having a qualifying income does not mean that a borrower will qualify for the FHA program. Credit history is also a determining factor. Regarding a borrower’s credit, FHA loans have looser standards than conventional loans. One great feature of FHA loans is that they do not require a high credit score. Normally, a FICO credit score of 580 is the minimum acceptable score. An extensive credit history is also not required. FHA loans generally do require a borrower to have two active lines of credit. The FHA even makes exceptions to that rule, if the borrower can demonstrate a solid payment history on payments for housing rental, auto insurance, and utilities.

FHA loans and delinquencies

A borrower can be disqualified from an FHA loan due to late payments on a previous mortgage within the last 12 months. If there is only one late mortgage payment in the past year and the borrower can provide a satisfactory explanation, the loan may be approved.

The presence of 30-day late payments to other creditors does not disqualify a borrower. The risk of not qualifying increases when a 60-day late payment appears. The FHA is looking for a pattern of responsible bill paying. If a responsible pattern has been established, an earlier period of serious delinquency could be ignored.

NSF checks are not likely to affect qualification. They rarely appear on a credit report and are not likely to be a topic of conversation in the FHA application process.

FHA loans and Bankruptcy

Regarding a Chapter 7 bankruptcy, the bankruptcy must have been discharged for 24 months, before an FHA loan will be approved. Please be aware that the discharge date is not the filing date. The discharge takes place after the bankruptcy court ordered all debts included in the Chapter 7 bankruptcy to be liquidated and then issued a notice of discharge.

A borrower can qualify for an FHA loan, even in the middle of a Chapter 13 bankruptcy! The payments to the bankruptcy trustee must be made as agreed for a one year period, the bankruptcy trustee must approve the loan payment, and the borrower must demonstrate job stability.

FHA loans and foreclosure

FHA loans generally require that the borrower not have a foreclosure or been issued a deed-in-lieu of foreclosure for the past 36 months. This is not a hard and fast rule. If a borrower can demonstrate a good payment history after the foreclosure and a reasonable explanation of why the foreclosure took place, the loan could be approved.

FHA loans and collection accounts or judgments

Minor collection accounts do not need to be paid in full in order to qualify for the loan. Judgments, on the other hand, must be paid in full.

FHA loans and Federal Debt

Any borrower with a federal tax lien for delinquent federal tax debt or who has delinquent federal student loans will not qualify for an FHA loan.

Non-purchasing spouse

A married borrower who wishes to purchase a home without his/her spouse, still must include the income and debts of the spouse on the application if the borrower resides in a community property state. A non-purchasing spouse may be required to sign a document acknowledging the transaction and relinquishing his/her rights to the property.

FHA loan appraisal requirements

FHA loans require an appraisal of the property's value to be made by an FHA approved licensed appraiser. An FHA appraisal is very thorough. It checks for the soundness of the structure as well as for health and safety issues. It is important for a borrower to keep in mind, however, that the FHA's acceptance of the appraisal does not protect the borrower; the FHA is not guaranteeing the condition of the property. If the home has a problem after the purchase, the borrower is solely responsible. This means that the borrower is well advised to pay for a separate home inspection, which is not the same as an appraisal

FHA loan limits

A potential drawback in the FHA loan program is the dollar-limit the FHA places on loans. These limits are set county by county. In areas that experienced high appreciation, the FHA loan limit may not be enough to purchase the home the borrower desires. Here is where you can review the FHA loan limits.

Non-occupying co-borrower on FHA loans

FHA loans allow as a co-borrower someone who is not going to reside in the home. The FHA program is far more liberal in this circumstance than conventional loan programs. In general, the non-occupying co-borrower is a close relative of the borrower. The non-occupying co-borrower needs to meet certain income and credit qualifications.

There are other types of FHA loans, aside from purchase loans. FHA loans are available for refinance and if someone already has an FHA loan, the FHA streamline refinance can be a simple and quick way to lower one’s interest rate.

Summary

The FHA loan programs are ideal for someone who may have been able to get a sub-prime loan a few years ago. It is a great loan product for someone who has less than perfect credit, whose credit issues do not allow him/her to qualify for a low-rate conventional loan. Even a bankruptcy that was discharged two years ago does not preclude a borrower from qualifying for a FHA loan. FHA purchase loans require a low down payment, whereas the days where conventional loans allowed a purchase with little or no money down are gone. Get free quotes on FHA loans at Bills.com.

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