The short of it is this: If you want to land a solid loan with minimal interest and least trouble you’ll need to go the traditional route. And for that you’ll need a solid FICO score and excellent credit history. That’s called a prime loan. Less than that and you’re into what called a sub-prime situation where you’ll need to seek alternative sources of funding. These will charge you higher interest to offset the loan and more intimidating terms of payment including prepayment. Your balloon payment, too, is going to be much larger than had you gone the traditional route.
Here’s to explaining your situation.
The ins-and-outs of credit scores
The government established the FICO system in the early 1950s, but the system only came into use comparatively recently due to banks and government-based lending intuitions having experienced a slew of defaulted loans (largely due to their looseness in approving borrowers). Today, government-based institutions only proffer loans after they have scrutinized credit history and credit accounts. The whole is calculated mathematically into has become known as your FICO score.
There are three agencies that distribute your FICO score: Experian, Equifax, and TransUnion. Scores range from 300-900. The higher the score the more likely your chance to win that mortgage or any loan for that matter), since lenders are more assured of your ability to repay.
Scores depend on the following:
- Late payments
- Non payments
- Current amount of debt
- Types of credit accounts
- Credit history length
- Inquiries on the credit report
- History of applying for credit
- Bad credit behavior which can be something such as writing bad checks
Scores that lenders love to see are 650 and above. Anything that is below that almost inevitably trashes your chance of getting a loan. Scores that hover around 620-650 require some looking into (lender wonders: is there trouble ahead?). The lender is particularly cautious if your scores fall short of 620. Prepare for more hurdles and a longer process with possible rejection at end. But if you exceed the 650 range, your chance of acquiring high quality loan with excellent interest rate raises proportionately. That is where you want to be.
Ways to improve your credit score
Here are simple ways to improve your credit score:
- Pay your bills on time – This particularly holds for mortgage and rent payment. Too many people fall behind (known in credit lingo as ‘become delinquent’ or ‘make delinquent payments’) due to mere laziness. Strike a historical demonstration of paying your bills on time. Your credit score will improve as a result. For example: A person with a credit rating of 707 can raise their score another 20 points by paying all bills on time for a single month. As easy as that.
- Low credit card debt – Keep balances low on credit cards. High credit card debt can hurt the credit score and lower the credit score by as much as 70 points.
- Be credit-card thrifty – No need to collect credit cards! The fewer the better. New accounts lower the account age subsequently lowering the score instead of elevating it.
- Manage your cards – Credit cards help you but you need to manage them. Lenders like to see that you pay on time; that you’re a credible borrower. Credit cards with a history of consistent payments supports that notion. Credit cards are better than none – as long as they’re well-managed.
- Watch accounts – Closed accounts have a habit of sticking around. They also affect your credit report.
Candidates for subprime mortgages
There are times when a dismal credit rating and spotty history forces the borrower to turn elsewhere. You’ll most likely have to search for an alternate source when you find yourself in one or more of the following situations:
- Your credit score is below 620
- You have at least two mortgage delinquencies of a month old in the past year
- One mortgage is delinquent by 60 days in the past year
- Your history shows a foreclosure during the past two years.
- You went bankrupt during the last 2 years
- Your debt exceeds your income by more than 50%
- You were unable to meet basic expenses in the course of a month
Nonetheless, consult with a broker or a professional who specializes in mortgage loans to see if such is your case. Sometimes, a couple of missing credit card payments does not mean that you are doomed to receive double-digit interest rates.
If you are turned down, there are various unconventional lending alternatives that you can consider. These include the following:
- Hard money loans – Where private lenders dole out funds that are based on the value of your collateral (mostly your property) rather than on your credit history and credit worthiness. Look out for low value to ratio ratings (where the money you receive is usually, although not always, disproportionately lower to the value of your property).
- Federal Housing Administration loan (FHA) – You’ll get liberal underwriting requirements which allow you to purchase a home with a poor credit score and as little as a 3% down-payment. Veterans may want to explore the VA option.
- Stated income loans – Also known as so-called liar loans. These come in handy for people who are self-employed. Lender trusts your account of your income and lends you accordingly. Since borrower disguises income, such loans have reputation for fraud.
- More credible is the 2/28 ARM, which offers a 2-year teaser rate and adjusts yearly beyond that.
Each of these options is excellent in that each caters to borrowers who, for some reason or other, have scores that fall below the 620 range.
On the other hand, borrowers suffer in that repayments are high (sometimes doubly higher than traditional loans) and come equipped with boggling interest rates. Many of these loans have a sharp increase in rates at the 2-year point, with the home buyer planning on refinancing at that point. However, if the mortgage market tightens or if the home buyer is unable to crawl out of his credit difficulties, the borrower may lose money and home ownership. So if you’re going this route, watch out for progressively higher repayments and huge balloon repayment at end. This bad credit mortgage option may be your best alternative…