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Published on: Nov 23, 2015 16:26:06
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 an 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 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.
You will probably be responsible for property appraisal and inspection costs. This can sometimes be added to the promissory note, but poor credit generally pays this obligation up-front. Homeowner’s association fees may also be an up-front expense. Finally, inspections may discover repairs for the HVAC, roofs, and plumbing that may not be included in the loan.
Securing a loan with bad credit is possible, but will require a large up-front investment. It will also mean a less than favorable interest rate. It is always recommended to have a narrative about the credit report and make all corrections. Ask about special programs and stay away from those with points. Look for solid properties to mitigate any repair costs. As you can see homeownership is an option for those with bad credit, it will just cost them more.