Low-credit
score loans
A mortgage is a major expense. But it can be even more costly
when your credit score is less than perfect as you may end up
being charged a higher interest rate for a subprime mortgage.
How do you avoid having to pay a higher rate? One way is to
pay down your debt, and establish a good track record of paying
your bills on time. But it can take up to a year to show
results.
There is another way, however, and that’s to consider an
FHA (Federal Housing Administration) mortgage. These loans use
different criteria than other mortgages, and that may allow
lenders to offer you terms only slightly higher than market
rates -- in some cases, as little as .125 percent higher.
FHA mortgages
It’s important to understand what an FHA mortgage is. Contrary
to some people’s belief, the Federal Housing Administration is
not a lender. It is a federal government agency that guarantees
loans by private lenders, making mortgages available to people
who may have a difficult time qualifying , often because of a
lack of credit history. This includes recent college graduates,
newlyweds, as well as people who have had credit problems
including bankruptcies and foreclosures. Since an FHA mortgage
is government-insured, lenders granting these mortgages assume
less risk than they do with other low credit score loans and
therefore can extend credit at a more reasonable interest rate.
How to qualify
The qualification criteria for an FHA mortgage are different
than they are for a conventional loan. While your credit score
is usually the most important factor lenders consider when
approving you for a conventional loan, with an FHA loan it’s
not the central consideration. Rather, the FHA looks at your
overall credit history, and is often more flexible in
considering mitigating factors.
That doesn’t mean you don’t have to get your credit under
control. The FHA requires a one-year period of acceptable
credit, during which you have made all your payments promptly.
It may review your rental or mortgage payment history during
that time, any new credit or credit inquiries, and whether you
have paid off any judgments against you. And it considers your
debt-to-income ratio to ensure you’ll be able to repay the
loan.
Advantages
- The FHA may not hold an unpaid collection against you if
there is a valid reason for not paying it.
- You can qualify three years after a foreclosure, as
opposed to the usual four years with a conventional loan.
- Your down payment can be as little as 3 percent of the
loan amount.
- The down payment can be a gift from a family member,
government agency or non-profit organization.
- Your housing expenses (PITI) and other debt payments can
total 41 percent of your income, compared with the usual
33-36 percent for a conventional loan.
Disadvantages
- There is a limit to the amount you can borrow that varies
depending upon your area.
- You may have to take out a second loan if, due to regional
limitations on the amount your can borrow, an FHA loan does
not provide you with sufficient financing.
- You will be required to take out FHA mortgage insurance.
In most cases, you’ll pay 1.5 percent of the loan amount
on closing, plus 0.5 percent per year. However, both of
these amounts can be rolled into your monthly payments, and
the total is likely to be less than that the cost of private
mortgage insurance on a conventional low-down-payment loan.
(On a $100,000 mortgage, the 1.5 percent upfront mortgage
insurance payment would be $1,500 which, wrapped into a
fixed, 30-year mortgage at 8 percent, would come to an
additional $11.01 per month. The 0.5 percent annual premium
would be $500 per year or $41.67 per month.)
While an FHA mortgage may be the answer for you, not all FHA
mortgages are the same. So look carefully at the rate and other
features, and compare FHA mortgages from different lenders
before you sign.
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