The bad credit mortgage is often called a sub-prime mortgage and is offered to homebuyers with low credit ratings. Due to the low credit rating, conventional mortgages are not offered because the lender sees this as the homebuyer having a larger-than-average risk of not following through with the terms of the loan. Lenders often charger higher interest rates on sub-prime mortgages in order to compensate for the higher loan default risk that they are taking.
The following table displays current conforming rates for people with prime credit scores. If you have a poor credit score you can expect to pay a significantly higher rate of interest on your loan & the loan is more likely to be structured as an adjustable-rate rather than a fixed-rate. The table also offers a credit score filter which allows you to find offers matching your FICO credit range.
Subprime have interest rates that are higher than prime loans. Lenders must consider many factors in a particular process that is called “risk-based pricing,” which is when they determine the terms and rates of the mortgage. Sub-prime rates will be higher, but it is the credit score that determines how high. There are also other determining factors like what kinds of delinquencies are recorded on the borrower’s credit report and the amount of the down payment. An example is the fact that the lender views late rent or mortgage payments as being worse than having credit card payments that are late.
In some cases borrowers may take a higher interest second mortgage to help qualify for a lower cost first mortgage.
Sub-prime loans are very likely to have a balloon payment penalty, pre-payment penalty, or penalties for both. A pre-payment penalty is a charge or fee that is placed against the homebuyer for paying off the loan before the end of the term. This early payoff can be because the borrower sells the home or they refinance it. A mortgage that has a balloon payment means that the borrower will have to pay off the entire balance in one lump sum after a specified period has gone by. This period is usually five years. If the borrower is unable to pay the whole balloon payment, they must refinance, sell, or lose the house. If a first time home buyer is working with a non-traditional lender it is typically worthwhile to have a legal and financial expert review the paperwork before signing the application.
Credit scoring is the method in which credit risk is assessed. It uses mathematics to determine a person’s credit worthiness based on their current credit accounts and their credit history. The system was created in the 1950s, but did not see widespread use until the last couple of decades.
Credit scores are numbers reported that range from 300-900. The higher the number is, the better the score. Creditors see this number as an indication of whether or not an individual will repay money that is loaned to them. The scores are determined by looking at the following data:
The score that creditors like to see is above 650, which is a very good credit score. Those who have credit scores of 650 and above will have a good chance of acquiring quality loans with excellent interest rates.
Scores between 620 and 650 indicate that a person has good credit, but does indicate there might be potential trouble that the creditors may want to review. A creditor may require the applicant to submit additional documentation before a loan will ever be approved.
When scores are below 620, the consumer may find that they can still acquire a loan, but the process will take longer and involve many more hurdles. Below this number indicates a greater credit risk, so more aspects have to be reviewed.
Many people have issues on their credit report which they are unaware of. Identity theft is a common problem in the United States & consumer debts are frequently sold into a shady industry. The first step in determining if you have any outstanding issues is to get a copy of your credit report. AnnualCreditReport.com allows you to see your credit reports from Experian, Equifax & TransUnion for free. While many other sites sell credit reports and scores, a good number of them use negative billing options and opt you into monthly charges which can be hard to remove. If you find errors in your credit report, you can dispute them using this free guide from the FTC.
Some people with poor credit profiles or a small down payment may have trouble borrowing from conventional lenders. One alternative to consider is obtaining a Federal Housing Administration loan. These loans have liberal underwriting requirements which allow people to purchase a home with a poor credit score and as little as a 3% down-payment. Some FHA borrowers have credit scores below 620. Veterans may want to explore low-cost VA loan opportunities.
Another common loan type among subprime borrowers is the 2/28 ARM, which offers a 2-year teaser rate and then adjusts yearly beyond that. Many of these loans have a sharp increase in rates at the 2-year point, with the home buyer planning on refinancing at that point. However if the homeowner still has outstanding credit issues or the mortgage market tightens up then they might not be able to refinance. The higher rate can cause a prohibitively higher monthly payment, & an inability to refinance can mean a loss of home ownership.
The below items are the general guidelines that can be used as a rough rule of thumb when determining whether a consumer may be a candidate for a bad credit loan:
However, overall creditworthiness is not determined exclusively by credit scores. A couple of missing credit card payments does not mean that a consumer is doomed to receive double-digit interest rates. The only way to know where one stands is to apply for the loan and speak to a professional specializing in mortgage loans.
The following are simple ways to improve credit scores