Buying a House with Bad Credit
If you’re interested in buying a home but your credit is less than ideal, there are a few things you should know before jumping into the process. There are many dangers of buying a house with bad credit, and knowing the best way to proceed before you get yourself into a bad situation is very important if you want to get into the house buying game the right way. We talked to Courtney Kline, our lender at Caliber Home Loans, about bad credit loans.
If you’re wondering how bad your credit really is in relation to buying a house, we put together a few examples to help.
With a conventional loan through Fannie Mae or Freddie Mac, any credit below a 620 FICO score will make it very difficult to get a loan. Their guidelines are established based on credit, risk, etc. A low credit score presents a much higher risk factor, so a conventional loan at a 620 credit score will have a dramatically higher interest rate than with a higher FICO score. For example, if a 770 credit score on a conventional loan had a 4% interest rate, a 620 credit score would receive a 5% interest rate, a full percentage higher. VA and FHA loans, adversely, can accept a credit score as low as 580, but they’ll have different requirements to go below a 620 score.
With an FHA loan, interest rates aren’t nearly as heavily affected by lower credit scores as they are on conventional loans. Your credit score also affects the mortgage insurance rate on conventional loans, while the rate is fixed at .85% on FHA loans.
FHA loans are a vehicle for the person that doesn’t fit into the conventional box well, according to Kline. FHA loans have much shorter waiting periods after bankruptcies, foreclosures, and short sales before you can buy a house again; on an FHA loan you can buy a home two years after declaring bankruptcy, or three years after a foreclosure, compared to seven years for both on a conventional loan. Many people are getting back into the market using FHA loans now that the economy has recovered.
For example, if we’re looking at an FHA loan on a $200,000 home, the payment would be around $1073 with interest on a 580 credit score, while a 640 credit score would lower the payment all the way to $954. The same difference applies to a VA loan, while a conventional loan would have an even larger difference.
Often times a client will come to us about buying a home and we’ll send them to our lender, who will run their credit and find out whether they’re currently qualified to start the home buying process. If their credit is less than ideal, Caliber Home Loans works with a credit repair company called River Stone Law. This company will launch investigations on your behalf with the three major credit bureaus and work with creditors that are reporting erroneous information to get that information removed.
Repairing Bad Credit
When you’re referred through Caliber, River Stone Law offers a deal of $199 for sign in and $99 per month for guiding you through credit repair; they’ll tell you what to do and how to do it, send out letters on your behalf, and get items removed from your credit that shouldn’t be affecting it. The best thing you can do to raise your credit score is to pay down credit cards that have high balances. Many times the lender will take on a loan and work on repairing the client’s credit before even putting the loan into process.
Credit repair takes time and differs case by case, but according to Kline, almost anyone’s credit can be repaired within six months. Many times it can be done faster than that, but it depends on the situation. In a recent case, paying down credit cards jumped a client’s credit score by 40 points, allowing the deal to happen at a better interest rate than it otherwise could have.
It’s important to note that when you’re applying for a loan, the person you’re applying with isn’t making the end decisions about whether or not you’re approved. It’s their underwriters that are approving you or turning you down. Fannie Mae and Freddie Mac buy most of the mortgages in the country, providing liquidity, stability, and affordability to the mortgage market. Lenders must follow the guidelines set by Fannie Mae and Freddie Mac in order to resell the loan; if they aren’t, the loan will be sent back and the lender now owns the loan. There are auditors checking loans sold to Fannie and Freddie, making sure that all of the conditions are met.
No lending company wants to own a significant amount of loans, no matter how large they might be, so lenders are careful to follow guidelines. Kline estimated that when lenders aren’t properly following guidelines somewhere around 10 to 15% of loans are returned to be owned by the company.
Another piece of the puzzle in bad credit loans is payment shock. Payment shock is the difference between what you’re paying now, and what your mortgage payment would be, and is only applicable to FHA loans as conventional loans have no payment shock factor. With a higher credit score, payment shock isn’t a factor in whether or not you can get a loan. Even with a 658 credit score and $25,000 available for a down payment, the interest rate and mortgage insurance on a conventional loan makes a considerable difference in price over an FHA loan.
With today’s modern technology, Fannie Mae and Freddie Mac both have automatic underwriting engines, allowing lenders to enter all the information of the borrower (credit score, income, assets, price range, etc.), and returning an automatic underwriting decision. From that, the required conditions necessary to comply with that loan are listed. This works for 80% of loans, but sometimes the underwriter will find additional conditions that cause issues.
For example, if your business is paying for your vehicle, the lender will require 12 months of checks showing that. If you had hail damage about a year ago, got the car paid off from the hail settlement and skipped a couple of months payments because you didn’t have the car at the time, we now don’t have 12 months of checks. That would be a hard stop condition for a loan. Similarly, if your landlord lost or forgot to cash a check in the chain of the past 12 months, the lender would require a written verification from the landlord that your rent was paid for that entire time period.
Lenders have to comply with the conditions given in addition to meeting the credit guidelines in order to get it past the underwriter, which later needs to get past the auditor.
As long as the automated underwriting engine approves the loan, a credit score of 620 or higher doesn’t have any reserve requirements or debt to income requirements on an FHA loan. Therefore you can buy a house without any reserves and still have a good interest rate. When your score is as low as 580-599, you can’t exceed a 31% debt to income ratio; adversely, a score over 620 allows a ratio up to 51 or even 52%, which makes a huge difference in your ability to afford a house. If you’re interested in figuring out your debt to income ratio, check out our mortgage prequalification article!
Fix Your Credit Before You Buy
Bad credit loans exist; there are people who will smile and tell you what you want to hear, then give astronomical interest rates, even up to 11 or 12%. There is now a no credit score program through FHA, which is a far better place to start than a “bad credit loan.”
Remember to pull your credit every once in awhile; Kline has seen credit scores dramatically affected by credit cards not properly separated in a divorce up to 19 years afterward. If you’re regularly checking your credit, you know where you stand and you can catch things like that before they do significant damage. Caliber Home Loans has the ability to do “what-if” scenarios on your credit, meaning they can see how paying off certain cards will affect your credit, and help you decide the most efficient way to start improving your credit. Many credit repair companies are a scam, so make sure to be careful about who you’re giving your money and information to. The best people to help you repair your credit are locals that you can meet with in person who has experience in the industry.
The right way to buy a house with bad credit is to not buy a house. The first step is fixing your credit, which is entirely possible with the credit counseling help of companies like River Stone Law. Fixing your credit first will get you into the game the right way, not the wrong way.