Bad Credit Mortgages
by Shawn Carvin, Senior Mortgage Banker
A lower credit score is a concern for many potential homebuyers. It’s also obviously a concern for lenders. But that doesn’t mean financing a home is out of the question for borrowers with lower credit scores. There are still options for buyers to obtain a bad credit mortgage, also referred to as a sub-prime home loan.
What’s considered bad credit?
Credit scores are determined by a combination of factors: the types of credit on record, timeliness of payments, length of credit history, frequency of credit applications, frequency of credit use, and the amount of available credit being used. Scores run from 300 to 850, with a score of 630 or below generally considered “bad credit.”
However, the qualification threshold for a traditional mortgage underwritten by Fannie Mae or Freddie Mac is 620, and some borrowers may be able to obtain a sub-prime mortgage with a credit score as low as 600. But these loans will have to be insured by the Federal Housing Administration.
What factors improve the chances of getting a bad credit mortgage?
Generally, an underwriter will want to know the reasons behind negative information on a borrower’s credit report. If missed payments are due to a period of unemployment, a lender may be more understanding, but if there is no reasonable explanation, the chances for that loan’s approval go down. If only late credit card payments are bringing the score down, rather than mortgage or rent payments, that will help improve the chances of approval of a bad credit mortgage.
Negative information on your credit report is not necessarily insurmountable. Lenders understand many situations that lead to bad credit scores. But it’s vital for potential borrowers to be able to explain what caused the late payments and other issues documented on their reports.
What are the terms of a bad credit mortgage?
Be prepared to pay a higher interest rate on a sub-prime mortgage. Some lenders won’t approve a bad credit mortgage without at least a 10% down payment, or unless the borrower has significant cash reserves to get them through a period of temporarily reduced income. A lower credit score represents a greater risk for the lender. While there may be perfectly understandable reasons for a borrower’s lower credit score, lenders will mitigate their financial risk by charging a higher interest rate.
Lenders may also limit the options for the type of loan. A 30-year fixed rate loan may be ideal, but a borrower might only be offered an adjustable rate mortgage with a two-year introductory rate. This provides borrowers an opportunity to build an improved credit history and refinance at a better interest rate down the road. Loan origination fees may also be higher, and some lenders will require a borrower to participate in a consumer credit counseling or training program.