Today,
there is still a general consensus that to buy a home you need to have 20
percent down and a good-to-excellent credit history. The good news is you
actually don’t need a large down payment or great credit in order to purchase a
home with competitive market terms.
Let’s
look at the characteristics of what a mortgage lender deems to be bad credit
when it comes time to qualify for a mortgage loan.
Credit score scale
- 740-800 Outstanding
- 720-740 Great
- 700-720 Good
- 680-700 Mediocre
- *620-680 Less than perfect, but approvable
A
mortgage company’s definition of bad credit might not be what a consumer
considers to be bad credit. A credit score of 620 or higher is required to
successfully obtain a mortgage. By the same token, a 620 credit score is
considered by a lender to be less than perfect, but it’s still possible to get
a mortgage with that score.
Your
credit score determines two major things for a mortgage company:
1. Loan
program — whether it’s a conventional or FHA-type mortgage
2. Pricing
— this includes your interest rate and any additional charges indicative of the
credit score (the lower the credit score, the higher the interest rate and/or
potential charges)
Your
credit history is the next factor in determining whether or not your loan will
be approved. Is there a pattern of previous credit delinquencies? Are there
balances on closed-out accounts? It’s common for a consumer to have a 620
credit score, and have a consistent historical pattern of derogatory credit. Interestingly,
this person would have a more difficult time obtaining mortgage loan approval
than someone with a 640 credit score with no history of delinquencies other
than a foreclosure from a couple of years before.
In
order of priority, lenders will look at the credit score to determine which
home loan you’re eligible for. Next, the complete credit overview will be taken
into consideration to determine what questions may or may not arise in the
underwriting decision process. The underwriting process will be looking for
“what happened,” “why it happened” and the future “likelihood of continuance or
repeat non-repayment.”
Common credit red flags for lenders:
Pattern
of delinquencies: A record of late payments is possible to work around, but more
lender scrutiny will be given to the size of your down payment and your
debt-to-income percentage.
Student
loan late payments: If you had a late payment on your
student loans within the past 12 months, you may be more likely to be approved
for conventional financing. Government financing — like FHA — does not take
kindly to delinquent federal debt.
Mortgage
late payments: One late payment in the past 12 months is permitted, so long
as it can be explained and, if necessary, fully documented.
Foreclosure: 36
months from the date of the foreclosure you’ll become eligible for a 3.5
percent down FHA loan; for a VA loan, 48 months and no money down
required; conventional loans require seven years no matter the down payment.
Short
sale: It takes 36 months from the date of the short sale until
you’re eligible using a 3.5 percent down payment FHA loan; 24 months with
the VA loan; 24 months on a conventional loan with a minimum down payment of 20
percent.
Bankruptcy:
With Chapter 7 (Chapter 13 is less common), you have 24 months from the date of
discharge until you’re eligible using a 3.5 percent down FHA loan; 48 months on
VA loans (still no money down required); and 48 months on conventional loans,
no matter the down payment.
Why you can get a mortgage with bad credit
There’s
a thing called investor overlays, which are adjustments to guidelines and/or
pricing created in favor of the lender. This is precisely why one lender can do
a loan for someone with bad credit and minimal (or no) down payment, and
another lender cannot do the loan in some instances.
Overlays
further protect lenders against potential future losses from the home loans
they originate, preserving profit margins and buyback risk (an event in which
the originating lender is forced to buy back from the investor if the loan they
made was not fully documented). Investor overlays tighten the screws on
borrowers’ ability to borrow. Put another way, it shifts risk — which
translates to cost — on to the consumer by means of limiting the ability to
borrow via higher loan fees, reduced purchase price, or lower debt ratio, to
name a few.
Note:
Every mortgage lender has investor overlays. It’s the nature of how mortgage loan in Colorado companies operate. The key is to work with a lender whose overlays are minimal.
Home buyer's homework
1. Know
your credit score, first and foremost (you can monitor your score for free
using a service like Credit.com’s Credit Report Card). Obtain a copy of your
credit report this will aid you in selecting the appropriate lender.
2. Get
as much supporting documentation as possible surrounding your credit challenges
so the story can be explained from A to Z.
3. When
speaking with a potential lender, be very specific. Do not be afraid to share
every detail of your needs and concerns, giving the most complete description
possible. Find out upfront if they have any additional conditions with regard
to credit history, as doing so could save you considerable time and money.
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