If you have any negative marks on your credit such as a late payment, default, repossession, lien, judgment or bankruptcy you probably think you’ll never be able to buy a house. Not so. If you have a steady and secure income that is high enough so you can afford to make the monthly payments, and you have a sufficient sum of money saved up for a down payment, you will probably be able to buy a house.
Think of it this way. For most lenders, making a home loan is a very safe investment. For one thing, the loan will be secured by the house. If you don’t make the payments, the lender can foreclose. In addition, in today’s economy, house values are rising or remaining steady that is, they are not going down. The $125,000 house you buy today may be worth $135,000 a year from now, simply by virtue of the economy. Even if you do default and the lender must foreclose, the lender could make back its investment.
Before You Start Looking
Nothing will frustrate you more than finding your dream house and then being denied a loan. Before you go house or loan shopping, do a little preparation.
Estimate how much house you can afford
As a general rule, most people can afford a house worth about two or three times their gross annual income, assuming a moderate amount of other long-term debts and payroll deductions. If you have no other long-term debts, you may be able to afford something a little more expensive.
Gather your paperwork
Make sure you have a copy of a recent pay stub; last year’s tax return; names and account numbers for your car lender, student loan holder, credit card issuers and other creditors; checking, savings and money market account numbers, balances and bank names; a list of your assets (other real estate, retirement plans, vehicles, etc.); and a copy of your credit report. The lender will get their own copy of your credit report, but it’s very important you know what your credit report says about you in advance.
Get a loan prequalification letter
This is a letter stating that you have been “prequalified” for a loan up to a certain amount, based on your income and credit history, and how much you’ll need for a down payment and closing costs. It stops short of guaranteeing ultimate loan approval, but it makes it clear that loan approval is all but certain. Any house purchase offer that comes with a pre-qualification letter will be that much more attractive to a seller who might be worried about the buyer’s ability to get a loan. For someone with compromised credit, a pre-qualification letter is often a must. A letter will state that you have been approved for a loan of up to “X” amount of money at an interest rate of “Y” or less.
To get such a letter, make an appointment with (or call) several lenders, discuss your financial situation and find out if you can prequalify. You are not shopping for the best loan with the most competitive rates, you simply want to make sure you can qualify for a loan. If you don’t have the time or inclination to call around, consider working with a licensed mortgage broker, a person who specializes in matching house buyers with mortgage lenders. Mortgage brokers subscribe to different computer systems that list various mortgages available in an area.
As you learn about available loans, you may be overwhelmed by the range of terms. Down payment requirements, interest rates, loan application fees and points (a fee charged by a lender for the privilege of making you a loan, expressed as a percentage of the loan amount) can vary tremendously among lenders and even with the same lender. One reason is simple competition. But another reason is that different types of loans are made available to different types of borrowers. What separates one borrower from the next is often each person’s credit history.
For many years, mortgage lenders wrote only “A” loans. An A loan was available to a person with flawless credit someone who had paid every personal loan, student loan, credit card and mortgage payment on time. Occasionally a person with a minor credit blip, such as a one-time late payment on an otherwise perfectly-paid loan, would still qualify for an A loan. A loans typically require little money down and charge the most favorable interest rate. Anyone who didn’t qualify for an A loan had only two choices: forego buying a home until all the negative marks came off the credit report, or borrow from a lender who required a huge down payment and charged near-credit-card interest rates.
Many mortgage lenders now write “B” and “C” loans for people with somewhat marred credit histories and “D” loans for people with very bad credit histories. The following describes B, C and D loans.
Some lenders require clean credit for the previous 12 months, but allow a few missed payments before that. Others permit one or two late mortgage payments, one late personal or student loan payment and few late credit card payments during the previous year. Late payments cannot be more than 60 days past due. B loans usually require more money down and interest rates are usually one or two percentage points higher than A loans.
Some lenders require clean credit for the previous 12 months, but allow a serious credit problem, such as a bankruptcy or foreclosure, a few years before. Others permit three or four late mortgage payments, five or six late loan or credit card payments or late payments more than 60 days past due. C loans usually require even more money down; interest rates are usually one to three percentage points higher than A loans.
D loans are available to people with very bad credit histories bankruptcy or foreclosure in the past year, or habitual late payments on loans and bills. D loans usually require lots of money down. Interest rates are usually at least 100 percent higher than for A loans.
Improving Your Qualification
If you don’t currently qualify for a conventional loan, consider doing any of the following to improve your chances.
- Wait a while In the meantime, you can save more money to make a larger down payment, watch some of the older negative comments on your credit report drop off and get more positive recent information into your credit report.
- Move to a more affordable area If what’s holding you back from qualifying for a loan is that you have too little money saved for the down payment, move to an area where your savings will go further.
- Buy with someone else You can improve your chances of qualifying for a loan if you’ll apply with someone who has excellent credit. I am not suggesting that you marry (or move in with) the first available person to come your way! But perhaps you have a friend who is house hunting, too. You can buy a duplex and apply for one mortgage for the entire purchase.
Other Ways to Finance a House Purchase
Obtaining a conventional loan from a mortgage lender is not the only way to finance the purchase of your house. Consider the following alternatives:
- Private financing Consider approaching a financially well-off friend or relative for a loan. Propose a written business deal. Ask to borrow the money at a rate less than you’d pay a conventional lender but more than your friend would earn on his money invested conservatively. For example, if the bank would charge you 7.25 percent for a mortgage loan, but would pay your friend Allan only 5 percent on his certificate of deposit, ask Allan to lend you the money at 6.5 percent a deal for you both.
- Seller financing Some sellers don’t need or want the money from the sale quite yet. Perhaps the seller will owe taxes on the profit or be concerned about losing the money to a long-term health facility. No matter what the reason, suggest to the seller that she “carry the note.” This means that you pay her your down payment and monthly mortgage payments a mortgage lender is not involved. While the seller should do a credit check and request a copy of your pay stub, her qualifying standards will be far less rigorous than a conventional lender’s.
- Mortgage buydown These are generally available to people buying a new home in a new house development. The developer prepays part of your mortgage payment for a few years to help you qualify for a loan. Some conventional lenders have provided buydowns for people buying existing, not just new, homes.
- Public financing Many state, county or local governments provide mortgage financing to first time homebuyers willing to buy in a “target” area, typically a low-income area, some of which have serious social problems. If this is an option you would consider, you may be in luck. These programs are generally available to people with moderate incomes who can afford a low down payment and closing costs, and can afford the monthly payments. Credit requirements are often relaxed somewhat.
Don’t despair. As one mortgage broker once said, “Find me someone with bad credit and I’ll find her a loan. Mortgage loans are safe and secure to a lender, who makes money by making loans, not by turning people down.”