Buying a Home With Bad Credit
How to get a loan with bad credit after foreclosure or bankruptcy
Put your fears about buying a home with bad credit aside. Just because you have bad credit or filed bankruptcy or gone through a foreclosure does not mean you cannot buy a home. You most certainly can buy a home with bad credit. But since a credit score is an important factor in the home-buying process, you're going to pay more than a borrower who has sparkling credit.
Many potential buyers think they can't buy a house if their credit has tanked, but that's not necessarily true. There is hope for those who want to buy a house, even if their credit is dismal. Let's look at how.
The Waiting Period After Foreclosure/Bankruptcy
- The period between bankruptcy filings is about seven years, but the ding to your credit report stays for ten years, which results in bad credit.
- For better rates with a conforming loan, the wait is four years after filing bankruptcy or a short sale.
- FHA guidelines are two years after a foreclosure, which means you could qualify for as little as 3.5% down. Three years with bad credit after a short sale. These guidelines allow for one year after a "qualifying" short sale, but lender overlays reject this notion.
- Hard-money lenders will often make loans six months after filing bankruptcy or foreclosure but may a require 20% to 35% down payment due to the bad credit. The interest rate will be very high, and the loan terms are not as favorable; many will contain prepayment penalties and be adjustable.
- Subprime lenders (not to be confused with hard-money lenders) rarely make 100% financed loans, even for bad credit.
How to Improve Your Score to Get a Conforming Loan
Even though you might think your bad credit disqualifies you from buying a home, that presumption is probably wrong. Don't write off your chances to buy a home with bad credit just because you believe this fallacy. Talk to a mortgage broker who specializes in helping borrowers with bad credit to buy a home.
- Obtain a major credit card. It's easier to get than you would think after a bankruptcy, for three reasons: a bankruptcy filing gives you a "fresh start," the lender knows you have no debt and you cannot file bankruptcy again for roughly another seven years.
- Show steady employment on the job for one to two years.
- Earn a regular salary or wage (this does not apply to self-employment).
- Save a down payment of at least 10%.
- Avoid late payments and continue to pay your bills on time; do not fall behind.
How FICO Affects Interest Rates
We spoke to Evelyne Jamet at Vitek Mortgage about the differences among FICO scores and how that relates to the interest rate borrowers are charged. The following numbers are in comparison to the interest rate a borrower with a 600 FICO score would pay who did not file bankruptcy or lost a previous home to foreclosure. This scenario assumes the borrower with bad credit is putting down 10% of the purchase price in cash and met the seasoning requirements above.
- FICO Score of 600 to 640: + 1.625% over prevailing rate. It means if a borrower with good credit is paying 5.875%, your interest rate would be 7.5%. A $200,000 amortized loan at 7.5% would give you a monthly payment of $1,398.
- FICO Score of 560 to 580: +2.875% over the prevailing rate. It means if a borrower with good credit is paying 5.875%, your interest rate would be 8.75%. A $200,000 amortized loan at 8.75% would give you a monthly payment of $1,573.
- FICO Score of 540 to 559: +3.425% over the prevailing rate. It means if a borrower with good credit is paying 5.875%, your interest rate would be 9.3%. A $200,000 amortized loan at 9.3% would give you a monthly payment of $1,653.
- FICO Score Under 540 to 500: +3.875% over the prevailing rate. This means if a borrower with good credit is paying 5.875%, your interest rate would be 9.75%. A $200,000 amortized loan at 9.75% would give you a monthly payment of $1,718.
- FICO Score Under 500: +6.25% over the prevailing rate. It means if a borrower with good credit is paying 5.875%, your interest rate would be 12%. With a FICO of less than 500, you will not qualify for a 90% loan, but you may qualify for a 65% loan. Therefore, you need to increase your down payment from 10% to 35%. A $200,000 amortized loan at 12% would give you a monthly payment of $2,057.
Comparing Identical FICOs Against Borrowers With No Foreclosure or Bankruptcy
A borrower without a bankruptcy or foreclosure with a 600 FICO would receive an interest rate of 5.875% (based on the above) and pay a monthly payment of $1183 on a $200,000 amortized loan. You can see that filing bankruptcy or having a foreclosure on your record, even with a FICO score of 600, results in an increase in a mortgage payment of $215 over that of a borrower without bankruptcy or foreclosure. However, that difference in payment will let you buy a home.
Alternative to Bank-Financing
Borrowers who are not satisfied with the rate offered by a conforming lender might want to look at buying a home with seller financing. Land contracts offer a viable alternative. Typically, seller financing offers:
- No qualifying
- Lower interest rates
- Flexible terms and down payments
- Fast closing
You will want to check with your lender every year or so to find out if you qualify for a refinance at a lower rate.
DISCLOSURE: Vitek Mortgage is a preferred vendor for my employing brokerage and enjoys an affiliated relationship with Lyon Real Estate. Evelyne Jamet handles loans only in New Mexico, Colorado, and California and suggests borrowers with bad credit contact a local FHA mortgage broker.
At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.