Many potential buyers think they can't buy a house if their credit has tanked, but that's not necessarily true. Bad credit, bankruptcy, or even a foreclosure don't necessarily mean you cannot buy a home. 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 or Bankruptcy
Foreclosure and bankruptcy do have a long-term impact on your credit, but this doesn't last forever. Bankruptcy stays on your credit report for seven to 10 years, depending on the type of bankruptcy. How this affects your ability to get certain loans will vary:
- For better rates with a conforming loan, the wait is between two and four years after filing bankruptcy or a short sale.
- FHA guidelines are two years after a foreclosure. This means you could qualify for as little as 3.5% down just three years after a short sale. These guidelines may be less strict after "qualifying" short sale in which you didn't miss any payments for the previous year.
- 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 a bad credit rating. 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
There's no reason to sit back and wait until bankruptcy or foreclosure are cleared from your credit report. Instead, you can actively work to improve your credit and standing with lenders while you wait. This will increase your chances of getting a new loan sooner rather than later.
- Avoid any late payments on any outstanding debt and continue to pay your bills on time.
- Obtain a major credit card and start using it regularly. It's easier to get than you would think after a bankruptcy, though you may have to apply for a secured card or one with a low limit.
- Keep your credit card balances below 30% of your total credit limit. For an even better effect on your credit, keep them below 10%.
- 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%.
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 compare the rate of a person in each range who also had a bankruptcy, foreclosure, or short sale on their record to a borrower with a 600 FICO score would did not file bankruptcy or lose a previous home to foreclosure. This scenario assumes the borrower with bad credit is putting down 10% of the purchase price in cash.
|Interest Rate Comparison|
|Credit score||Extra interest||Extra monthly payment on 30-year, $200,000 loan|
|600-640 (NO foreclosure or bankrupcy)||0%||$0|
|600-640 (w/foreclosure or bankruptcy)||+1.625%||+$215|
|560-599 (w/foreclosure or bankruptcy)||+2.875%||+$390|
|540-559 (w/foreclosure or bankruptcy)||+3.425%||+$470|
|500-539 (w/foreclosure or bankruptcy)||+3.875%||+$535|
|Below 500 (w/foreclosure or bankruptcy)||+6.25%||+$893|
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 $1,183 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, you'll still be able to buy a home.
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 12.125% would give you a monthly payment of $2,076.
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 are one example of this, and can be a viable alternative. Typically, seller financing offers:
- No qualifying
- Lower interest rates
- Flexible terms and down payments
- Fast closing
Whichever lending option you choose, you should check with your lender every year or so to find out if you qualify for a refinance at a lower rate. As your credit continues to improve, better rates will open up to you.