How Do Bad Credit Loans Work?
You would also need to be aware that you might be required to put down a higher down payment when buying, than if you would have good credit. In addition, the interest rate you would pay might be higher than for those with good credit.
First, you should check with a lender. Lenders report that some potential borrowers wrongly think their credit is too bad to get a loan to buy a home, and the lenders actually consider their credit fine for lending purposes. On the other hand, some borrowers are unaware that their credit is as bad as it is and are surprised when they have trouble obtaining a loan.
It would first pay to understand your credit score. Lenders use two systems to rate credit. Under one system, a potential borrower would be given a score with a letter grade, under which, F represents credit as bad as it can get; D is for those with very bad credit; C is for those with fairly bad credit; B is for those with credit with some problems; and A is for those who have the best credit.
Under the other type of scoring, someone is given a numerical score similar to a SAT score. Under that system, 800 is for those with excellent credit, and 400 is as bad as possible. The three major credit reporting bureaus assign the scores such names as FICO score, Beacon, or Empirica, and each agency has its own system to determine creditworthiness. The scores would also affect any letter grades for credit.
Next in deciding whether a potential buyer would qualify for a loan would be the ratio between the amount being borrowed and the value of the property being placed as collateral, or Loan to Value (LTV). For example, someone obtaining a 70% LTV loan and wanting to buy a $200,000 home could get a loan for $140,000. If someone is seeking to refinance a home instead, only the appraised value may be considered.
If an LTV loan would not be enough for the house, it might be possible to get help from a family member or a down payment grant.
The debt to income ratio is also used to determine whether some qualifies for a loan by adding all the borrower’s debt payments, such as not only the loan being applied for but auto loans, consumer debt, and credit cards. This number is divided by the net cash available in a month. Most lenders would like that number to be 40% or less, and for some loans that would be a requirement. Some sub-prime lenders, however, will allow the number to be as high as 55% to 60%. Such flexibility in obtaining a loan, however, will result in a higher interest rate on monthly payments.
Those with bad credit can expect to pay more points, more interest, and a higher down payment. Some lenders will try to take advantage of those with good credit, however. You should not enter into such an agreement, if you have good credit.
Some lenders will also try to take advantage of those with bad credit. While those with good credit might pay no points on a loan (a point is a fee corresponding to one percent of the loan), those with poor credit might expect to pay up to four or five points. Some brokers might try to charge you up to ten points, however, and that is not accepted practice in the industry, at least unless the loan is for a small amount, such as $15,000.
Another thing to be aware of is something called “Back End Points.” A lender might pay those to a broker to make a particular loan. It might also represent a payment from a lender to a broker for a loan with a higher interest rate. As an example, a borrower might get a loan at 10% interest, but the broker will actually only offer an 11% rate to the lender, to get two points from the lender.
There might be no problem with the points, if they amount to 1% or less, but some brokers charge points far in excess of industry standards. It might not even be possible to know what is happening to you, unless you know interest rates, or mandated reporting exists. If the reporting is done, look for back end closing points on HUD1 closing statement near the top of page 2. It might also be called a “yield spread premium.”
There are many lenders listed on the Internet that offer bad credit loans. Many legitimate lenders are experienced at finding loans for those with bad credit with the best terms possible.
According to a Federal Department of Housing and Urban Development (HUD) website,
www.hud.gov/offices/fheo/lending/index.cfm, “Subprime loans play a significant role in today’s mortgage lending market, making home ownership possible for many families who have blemished credit histories or who otherwise fail to qualify for prime conventional loans. A recent HUD analysis …. shows that the number of home purchase subprime applications increased from 327,644 in 1997 to 783,291 in 2,000.”
The website also states the loans are legitimate but “cost more and sometimes have less advantageous terms than prime market loans. Additionally subprime lenders are largely unregulated by the federal government.” Also, many people who do get such loans would actually qualify for a more typical loan with better conditions.
HUD itself also has programs to help people buy houses.
It might be possible for you to buy a house, even if you have had bad credit in the past. It would pay to do research on lenders and pick one you trust before making a decision. Check also for government programs.
