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How Can I Get a Loan With This Credit Score?

Mortgage Options for the Unlucky and those Who've Made a Few Credit Mistakes

You're a responsible person at this point. You're trying to do everything right. You have a good job. You want a home of your own, maybe start a family. But with the big black marks on your credit report, you're afraid you'll be laughed out of the bank if you go in asking for a home loan. What can you do?

Things are probably not as bad as they seem. While a person with a low credit score can have more difficulty getting a home loan, if you are realistic as to what you can handle, and go in with an open mind, there is likely someone out there who can help you. Still, be cautioned that it will probably be a more difficult process for you than for most. Lenders have tightened their standards considerably with the foreclosure crisis. Even if your credit score hasn't recovered, you will need to have a solid, stable source of income and have handled your credit responsibly for at least the past year. If you don't have these things in place, you probably aren't ready for that home loan anyway.

Despite their infamy, a subprime loan is nothing to be ashamed of. It is simply a classification given to higher-risk loans, generally for the sake of the secondary mortgage market, where mortgages are bundled into securities and sold.  

Mortgages to people with credit scores of 640 or below are generally classified as subprime. Despite their infamy, a subprime loan is nothing to be ashamed of. It is simply a classification given to higher-risk loans, generally for the sake of the secondary mortgage market, where mortgages are bundled into securities and sold. They can be very helpful to someone in your situation. But there are a few things you're going to have to accept beforehand.

The worse your credit score, the higher your interest rate will be. This is because you are perceived as being at greater risk for default. Loans are, in effect, investments by the entity issuing them, and as with any investment, higher risk demands a higher return. Your payments will be higher for the same loan amount than they would be otherwise, which means that a loan which is affordable to you will buy a lower-priced home than otherwise. Still, if ownership of a home is important to you, such a loan will get you in the door.

However, your loan need not have an overwhelming rate of interest, even if your credit score is poor. The Federal Housing Administration (FHA) is a federal agency that provides backing for loans issued to people in your situation. By providing guarantees to private lenders (such that they will compensate them if you will default), they enable the lenders to offer you a mortgage at a manageable interest rate. Again, it is risk that is at the core of it; the FHA reduces the risk, and so reduces the return necessary to entice the lender.

While your credit score need not be great for an FHA loan, you still need to meet some requirements. You must have, for a year prior to taking out the loan, treated your credit in a way the FHA deems acceptable. It is important to make payments on time on debts as well as judgments and any rental or current mortgage. However, the FHA is more accepting of mitigating circumstances in this regard than a lender acting alone would generally be. They will also examine any new credit card applications you have made, and your debt-to-income ratio.

There are disadvantages to FHA loans, too. You will usually have to pay mortgage insurance to the FHA for their backing of your loan. This will add to your monthly payment, on top of the already higher interest rate. There is also a limit on the loan amount they will guarantee, which varies depending on the average home prices in your area.

There are private mortgage brokers that offer loans to those with bad credit scores without FHA backing. In some areas, Fannie Mae or Freddie Mac backed loans may be available. Shop around and ask questions of the banks and brokers in your area. Even though the interest rates will be lower, take into account the insurance costs when considering an FHA-backed loan against other loans available to you. But one way or another, there may well be more options open to you than you ever thought possible.

The Daily Bang