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Step 1
Find out just how bad your credit is. A bad credit home loan can range from very high, predatory interest rates to a rate moderately higher than a home loan for customers with good credit. Research your credit score ahead of time so that you will know how your credit ranking will affect your interest rate and ability to obtain a home loan. Don’t be swindled into a loan with an unnecessarily high interest rate if your credit score is decent enough to obtain a better rate.
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Step 2
Take steps to improve your credit and devote extra cash to paying down your debts. A good rule of thumb is to keep your revolving credit account balances at 50% or less of your total credit limit. Remove recent credit inquiries, if possible, and be sure to make monthly payments on time. For many people, credit scores fully recover after a year of positive payment history, but even a few months can bring a credit score up enough to be able to qualify for a bad credit home loan. These few months of preparation can make all the difference between an affordable home loan and one that will inevitably end in foreclosure.
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Step 3
Consider the affordability of a home loan. Take into account your debts and income, and figure out how much you can realistically afford to pay each month for a mortgage. Don’t forget to factor in property taxes and homeowners insurance, and private mortgage insurance if your down payment will be less than 20% of the home’s purchase price. (In the past, PMI was often avoided by an 80/20 mortgage, but these mortgages are virtually non-existent in the current market, since they carry added risk for the second mortgage lender.) In considering your ability to pay a mortgage, you should consider your debt-to-income ratio, which is your total minimum monthly debt payments divided by your income. The industry standard for debt-to-income ratio is generally 40% or less. Bad credit home loan lenders will often allow DTI ratios up to 60%. Just because this is the case doesn’t mean you should obtain a home loan with such a high DTI – be realistic about how much you can afford.
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Step 4
Shop around. Make sure you know typical home loan rates so you can see if the rate you are quoted compares favorably with the market. In addition to your credit score, your expected loan-to-value ratio (amount you borrow versus the value of the home) and debt-to-income ratio also affect loan points and interest rates. Bad credit home loans often allow for greater loan-to-value and debt-to-value ratios, but this added flexibility comes at a price in the form of loan points and higher interest rates.
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Step 5
Consider obtaining an FHA loan. Loans through the Federal Housing Administration aren’t based on credit score. You will need to be able to make a down payment equal to 3% of the purchase price of the home, and the home will have to meet certain criteria. Your 3% down payment cannot come from a source that requires repayment. A family member can gift you the 3% down payment, for example, but a loan would not be acceptable.
Comments
tjzerrer said
on 7/14/2009 Excellent advice. Fix your credit first, or at least know your current credit score. Information will save you money.
ccallahan916 said
on 12/17/2008 Nice article...and very timely considering current economic conditions.