Getting a Mortgage with Bad Credit - What to Expect from 'Sub-Prime' Lenders

Forty years ago, people with bad credit had virtually no chance of owning their own home. Luckily, there have been numerous financial innovations since then that allow almost anyone to purchase the home of their dreams. Of course, with these innovations come a cost - namely, high interest rates and complex mortgage contracts that unsophisticated borrowers may not fully comprehend when they sign the dotted line. As someone with bad credit, it is important for you to know what to expect from so-called "sub-prime" lenders.

Are You a Candidate for a Bad Credit Mortgage?

Mortgage lenders take the following criteria into account when deciding whether to offer you a conventional mortgage or a bad credit mortgage:

1. Your credit history

2. The LTV (loan-to-value) ratio of the house you want to buy

3. Your PTI (payment-to-income) and DTI (debt-to-income) ratios


Let's look at each of these aspects one-by-one:

Your Credit History

You may be a candidate for a bad credit mortgage if you have a FICO score of 620 or lower, but your most recent credit activity is most important. For example, if you have a credit score of 619, but you have absolutely no blemishes on your credit for the past 24 months, you may not require a bad credit mortgage. Conversely, you could have a much higher credit score, but if you've had numerous delinquencies in the past year or two, your mortgage lender may view you as being high-risk.

Loan-to-Value

But your credit history is not the only factor that determines whether you need a bad credit mortgage. Another important aspect of risk is the LTV ratio, which compares the amount of the loan you're requesting to the value of the underlying property. If you wanted to borrow $150,000 for a $150,000 home, then you would pose more risk to the lender than if you wanted to borrow just $50,000 for the same house. Lower lender risk not only means lower interest rate payments for you, it may mean that you qualify for a conventional mortgage and do not need to seek a bad credit loan.

Your Income - PTI and DTI

Your personal income is another very important factor in determining whether you need a bad credit mortgage, and once again, it's all about risk. If you earn only $24,000 a year ($2,000 a month) and your monthly mortgage payment is going to be $1,000, then your PTI (payment-to-income ratio) would be 50%, meaning that your mortgage payment would represent half of your income. This is far riskier to a lender than if your PTI were in the 25-30% range, where mortgage lenders like to see them. But two people each earning $2,000 a month are not necessarily equal. What if Bob has $600 a month in car payments, $500 a month in child support, and another $150 in credit card bills? He is far riskier than Susan, who has only a $90 monthly student loan bill. Thus, DTI (debt-to-income) takes all of this information into account.

Expect to Pay More

If you fit the profile of a "sub-prime" borrower, expect to pay a higher rate of interest. Mortgage rates go up and down over time, but as of early 2007, people with good credit could expect to pay less than 6%, while bad credit borrowers may pay more than twice that. This can add up to thousands of dollars in just a few years, so be very cautious before committing to a mortgage contract. If the deal seems too good to be true, it probably is. In recent years, mortgage lenders have made a killing by taking advantage of people with bad credit by giving them loans that they don't understand. For example, you may have a loan that seems affordable, but a few years later, your payment goes up by 50%. Or worse yet, some loans become due (in full!) in relatively short order, causing homeowners to sell their houses at a loss in order to fulfill their mortgage contracts. Bad credit mortgages are a great thing so long as the borrower understands their terms, but everyone should have the goal of not needing to rely on them. Even if you do need a bad credit mortgage, the smart thing to do is to begin rebuilding your credit so that you can refinance with a conventional mortgage and save a lot of money. For more information on how this can be done, browse around Debt Relief USA.

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