You do not have to have stellar credit to get a mortgage loan in 2017. In fact, there are still bad credit home mortgages available.
When we say, ‘bad credit,’ we mean it is possible to in some cases to get a mortgage with a 600-credit score or below. It also is possible to get a loan even with no credit at all.
But when you are learning how to buy a house mortgage with bad credit, there are some reasons to be extra careful so that you do not end up making a bad financial decision:
#1 High Interest Rates
There are some bad credit home mortgage loans on the market where you may need to pay well above market rates to get the loan. This is because you are a higher risk to the lender with bad credit, and the lender has to be compensated for taking the higher risk.
Some home owners are so tired of paying rent that they are willing to say, ‘the heck with it’ and pay whatever rate they have to, as long as they stop renting. But is this wise?
If you have to pay well above market averages to get a home loan, it may not make sense to buy a home at all. Perhaps you are better off with improving your credit and renting for another year than getting a bad-credit home loan.
#2 Balloon Payments
Subprime loans may have a balloon payment at the end of the term. This means that at the end of a five or 10-year term, the full loan balance is due. If you cannot pay it, you have to refinance it, or failing that, you can lose the home.
Balloon payments led to a lot of problems in the last economic down turn. When subprime borrowers came to the end of the initial term, many could not refinance because they lost their jobs and income. This led to hundreds of thousands of home-foreclosures.
If you are considering a loan with a balloon payment, you should probably run your contract by a legal and financial professional to make certain you understand what your financial obligations are at the end of the initial payment period. Review all types of amortization schedules, even for home loans with no money down.
#3 Pre-Payment Penalties
Some bad credit home buyers get a high interest loan but improve their credit, and then want to refinance into a regular mortgage. This can be a smart idea. But watch out for pre-payment penalties on the original loan. Some lenders will charge you thousands of dollars on the first mortgage if you want to refinance. This can put you in the ugly situation of either continuing to pay a higher rate than necessary, or taking a financial beating with a pre-payment penalty.
It is advisable to not sign onto a first mortgage with a pre-payment penalty. Check the paperwork to see if a pre-payment penalty is involved.
#4 High Mortgage Costs
Every mortgage loan has closing costs. You should expect closing costs of 2-5%. Some mortgage lenders for bad credit may be willing to work the closing costs into the loan with a higher rate. But all closing costs need to be clearly disclosed under federal law, and how they are being paying and who is paying them.
When you are getting a bad credit mortgage, there are some lenders that may charge you higher fees. They might do so simply because they assume you are desperate and won’t say anything. Don’t be a sucker. We advise shopping for a mortgage and checking with a minimum of three bad credit mortgage lenders. Compare the fees and closing costs. If one is much higher than the others, ask why.
#5 Not Getting Paying Points Option
On conventional home loans, you often can ‘pay points’ to get a lower rate. Borrowers commonly purchases points at the start of the loan to lower the interest rate. If your lender does not allow you to do this, you should ask why. See if no doc home loans are available for your situation.
#6 Lenders Who Don’t Disclose Compensation
Everyone makes money in the loan making process. If your lender and loan officer does not clearly disclose what they are getting paid and how, you should look for another lender. It is likely that the loan contains very high fees and they are making more on the loan than is fair. After all, if they are being compensated fairly, why are they not disclosing it clearly?
#7 No GFE
Every mortgage loan company is required by federal law to provide you with a good faith estimate or GFE within three business days of receiving a mortgage loan application. This document provides you with all basic information about the proposed loan, such as estimated cost and payment. This estimate must come on a standard HUD GFE form. If you do not receive this document on the standard form and within three business days, get another loan company.
#8 Fees Are Different Than Disclosed on GFE
Your GFE must have a list of loan costs with exact figures. It will not always stay the same because the loan costs can fluctuate before the loan is finalized. For example, the rate could change and that affects the entire loan. So some loan fees can change, but others should not change. Credit check fees and appraisal fees, for instance, should not change.
#9 Owner Finance Loan Traps
Sometimes your credit might just be too bad, or nonexistent, to get a mortgage loan. The last option is to get an owner-financed mortgage. This is where the home owner gives you a mortgage. You provide the owner with some amount of down payment, and the owner agrees to finance the rest. You pay him a monthly payment just like you would to a mortgage company.
This type of deal can work out just fine, but there are all sorts of areas where the financially illiterate can get completely screwed.
First, you will pay a high interest rate of up to 10% in many cases. It is up to you whether you want to pay that, but you should be able to refinance the loan as soon as your credit improves. Do not agree to a pre-payment penalty.
Also, make sure that you have an amortization schedule that shows what you are paying each month, and how much is going towards principal and interest. It is a very good idea to have any owner finance real estate contract reviewed by a real estate attorney. We suggest that you learn as much as you can on how to get approved to buy a home with bad credit scores.
The Bottom Line
The deal with bad credit mortgages is that people can get desperate to get out of a bad financial circumstance, and not be as diligent in their financial decision making processes. Be sure you fully understand the loan terms you are signing onto, and have the ability to refinance out of the poor credit mortgage and into a regular mortgage as soon as you can improve your credit.
Also remember that there are government-backed loan programs, such as FHA, designed for people with bad credit as low as 580. You can often qualify for 3.5% down and low interest rates too, so remember that you may have more options than you realize.