Bad credit does not preclude you from becoming a homeowner. In fact, there are several options available for those interested in home ownership that have bad credit. Being prepared with information about the process followed by taking appropriate steps yields a successful result. Here is a detailed review of factors to consider regarding the borrower, lender, and property categories.
The first step for the borrower is to obtain all three credit reports, and review them. If there is information that should be corrected, ensure they are updated. Take a look at your personal finances to see how much income is available after all monthly expenses have been paid. This is called the debt to income ratio. Good credit generally secures loans with a 33% ratio, while poor credit scores may be as low as 20%.
The biggest incentive for a lender is the amount of down payment the borrower is willing to invest. This is called earnest payment and shows good faith about the borrower’s intentions to close the transaction. This is also known as sweat equity. The requirement is usually around 20% for good credit, but could be as high 50% with low credit scores. Your broker will establish an escrow account and deposit these funds for disbursement at the closing.
Lenders have categories of home loan products based on credit scores. A traditional 30 years fixed FHA loan is most common or a VA program for veterans. Ask about special programs for low credit scores. The APR (Annual Percent Rate) and mortgage loan interest rate on all loan types will be higher for bad credit. Lenders can add points to the interest rate based on credit scores. An example is an interest rate of 4% with five points becomes 9%. Lenders will also open an escrow account to hold funds for property taxes and homeowner’s insurance for the life of the loan. If property taxes are a main concern for you, feel free to read our blog regarding the top 5 most favorable States for Property Taxes.