When applying for a mortgage, your credit score is vital. It will determine whether you can get a loan, exactly how much you can borrow, and how much that loan is going to cost you in interest over the life of the loan.
If your credit score is below the 550-580 range, it usually means you're a non-conforming borrower, and you may have to find home loan financing with either a sub-prime lender or get qualified for a Federal Housing Administration (FHA) home loan. In this article, we'll cover both options.
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1. Sub-prime lenders who offer "bad credit" mortgages.
A sub-prime lender is essentially any lender that offers financing to borrowers who don't qualify for loans with other mainstream financers. Typically, their interest rates and closing fees are higher than the rates you'll find with traditional lenders, but their qualification requirements are more lenient.
Sub-prime lenders will base their fees and rates on the same formulas as prime lenders. Basically, the lower the credit score, the higher the rate or the higher the down payment, the lower the rate. Because a higher percentage of sub-prime loans will go into default or foreclosure, this is their way of covering that risk.
When dealing with a lender who specializes in sub-prime or "bad credit" mortgages, always explore your options. Try first for a traditional mortgage, and then if you're denied, shop around for an alternative lender. Get a variety of rates, and don't settle for the first offer that comes your way.
2. Federal Housing Administration (FHA) home loans.
The Federal Housing Administration (FHA) is a subsidiary of the United States Department of Housing and Urban Development. They offer a home loan program that gives free mortgage insurance to less-than-qualified home buyers.
Basically, if you only have a down payment of 3 percent of the home market value or your credit is less than perfect, you can still qualify for a mortgage through the FHA home loan program. By providing mortgage insurance, the FHA home loan can get you a better interest rate and save you the expense of private mortgage insurance (PMI) which can cost you hundreds of dollars a month.
You'll still need to meet certain credit standards to qualify for the FHA home loan program, but the criteria are less strict. The Federal Housing Administration also offers ongoing support to buyers. This means if you do come up against hard financial times, they can help you negotiate and deal with your lender to avoid foreclosure.
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