Qualifying for a mortgage can be one of the more frustrating aspects of the steps to buying a house, even if you have great credit. On the other hand, if your credit is bad or damaged, getting a loan will be even more difficult, but not impossible.
Bad Credit, Bankruptcy, Short Sale and Foreclosure don’t mean you’ll never be able to buy a house; they are merely setbacks that you can overcome. Armed with a little knowledge and a bit of patience, you can navigate the mortgage application and approval process, even with less than perfect credit.
Buying a House with Bad Credit
Bad credit or the idea that you have bad credit is the most common reason people don’t buy homes. It’s becoming increasingly difficult to even rent a home with bad credit. So, if you want more control over where you and your family live, repairing bad credit needs to be a priority.
If you're looking to buy a home with bad credit and can't wait to repair your credit, there are certainly private lenders out there that will make those loans. “Private Money Lenders” act like banks and much like a bank will require insurance on the property as well as their name on the deed. Of course, these loans have much higher interest rates and shorter terms than traditional loans because the risk is much higher. You the borrower will be paying a premium for this risk. Evidence that these investments are lucrative is the fact that there are even private money lenders that will loan with no credit check or loan amortization.
If you choose to pursue this method of financing, make sure you look at things like better business bureau ratings and online reviews. In the long run, you're much better off repairing your credit before buying a house.
The idea is to get you to a point where your credit score is high enough to qualify for an FHA loan. FHA requires a FICO score of 580 to be eligible for their 3.5% down payment program.
We don't have time to discuss all the merits of an FHA loan in this article. If you'd like to know more here's a great read by Kevin Vitali: Should You Get an FHA Loan?
Before we worry about what your FICO score is, we first want to pull your credit report and see how that looks.
Rip that Band-Aid off
Good news or bad news, it’s important to know the status of your credit health. And if you’ve suffered some bumps in the road credit wise you may be hesitant even to take a look. This is understandable, but at the end of the day, you need to take this first step.
Federal law requires the three national consumer credit reporting companies - Equifax, Experian and TransUnion, give individuals a copy of their credit report for free every 12 months, all you have to do is ask for it. The best first step is to check your report at www.annualcreditreport.com.
Once you have a copy of the report you’re going to want to comb through it and look for the following:
- Verify that all of the personal information on the report is correct. Check your name, address, Social Security Number, etc…
- Next, you’ll go through the individual accounts and loans to make sure they are correct as well. You want to ensure accounts from a person with the same or similar names don’t appear on your report.
- Another thing you want to look for is any accounts that were created as a result of identity theft.
- Check for Incorrect account statuses. You are looking for things like, closed accounts that are still being reported as open.
- Accounts that are incorrectly reported as late or delinquent
- Incorrect date of last payment, date opened, or date of first delinquency
- The same debts listed more than once ( perhaps with different names)
It’s important to note that if you are already applying for a mortgage, you should not dispute any derogatory information on your credit report. If your report shows that you are in the middle of a dispute, your loan application will be rejected, or it will be referred to a person (instead of a computer) for a “manual underwrite,” which can take a very long time to resolve. Wait until your mortgage is approved and then dispute the report.
If on the other hand, you are in the process of repairing your credit to get a loan, your next step is to address the incorrect or negative items on your credit.
If there is erroneous information or negative reporting based on late or missing payments on your credit report, you have a couple of options. The first option is to contact and pay a company to handle this for you. If you choose this option, be careful and seek references. We refer our clients to River Stone Law. This firm offers a deal of $199 for sign up and $99 per month for guiding you through credit repair; they’ll tell you what to do and how to do it, send out letters on your behalf, and get items removed from your credit that shouldn’t be affecting it.
On the other hand, if you decide that you would like to handle your disputes with the credit reporting companies yourself, here’s the breakdown.
You’ll need to contact the appropriate reporting company directly to handle any disputes. These disputes can be submitted online or by mail. Here are the sites you’ll need:
Additionally, the Federal Trade Commission has some great information about disputing items on your credit report. https://www.consumer.ftc.gov/articles/0151-disputing-errors-credit-reports
Prequalification and Preapproval
Once you know the erroneous information items have been corrected, it’s time to move forward with the pre-qualification and pre-approval process. If you’ve done your homework and cleaned up your credit report, your lender will want to run your application through a system known as Desktop Underwriting.
To save time and alleviate frustration, you’ll want to seek pre-approval through “Desktop Underwriter” (DU), this is the quickest path through the mortgage maze. “Desktop Underwriter” is a software program used by mortgage lenders to qualify prospective home buyers using Fannie Mae and Freddie Mac guidelines. Although Desktop Underwriting is used for Conventional and FHA loans, VA has it’s own automated system as well “Automated Underwriting System” (AUS).
The counterpart to desktop underwriting is "Manual Underwriting" this is a long, arduous process. You must avoid manual underwriting unless it's your only option.
Buying After Bankruptcy
Let’s go a step further and talk about another financial stress point many people think spells doom for their prospects of home ownership, Bankruptcy.
Bankruptcy. Yes, you can be approved for a mortgage even if you’ve declared bankruptcy. If you have declared a Chapter 7 bankruptcy (one in which all debts are forgiven), you must wait 2 years after the bankruptcy is discharged to qualify for an FHA or VA loan. For a Chapter 13 (when you agree on a repayment plan), if you have been making on-time payments for one year after the declaration, you may qualify for an FHA or VA loan. In either case, you must not have a single late or missed payment during the post-bankruptcy waiting periods—if you do, the qualifying period will be reset close to the date of your missed payment.
For conventional (non-government insured) loans, the waiting period is 4 years after the discharge of a Chapter 7 bankruptcy and 2 years after the 1-year payment period for a Chapter 13 bankruptcy.
Short Sale and Foreclosure
If you go through a short sale (selling your home for less than the outstanding debt), your credit score will not be affected if the lender notates it as “Paid as agreed.” If your lender agrees to forgive a portion of your loan, you will most likely sign an unsecured note promising to pay back the agreed-upon amount. As with Loan Modification, have your lender give you written proof that “Paid as agreed” will be reported to the credit bureau. If you don’t take this step, and the lender notates “Settled for less than the full balance,” you will be dinged a whopping 105 points!
If you are experiencing foreclosure, in which the lender takes possession of the property due to non-payment of the loan, you will also want to negotiate with the lender about how he will report it. If the notation “Foreclosure” appears on the report, you will be dinged 110 points.
In both cases, with a potential short sale or foreclosure, speak to your lender as soon as you realize there may be trouble looming. Don’t wait until the situation becomes dire, as many lenders are now much more willing to negotiate help for homeowners than in previous years.
- Dan Barcelon-5 Tips to Get Financially Ready to Buy a Home: http://epirealestate.biz/real-estate-blog/5-tips-to-get-financially-ready-to-buy-a-home/
- Luke Skar-10 FHA Guidelines EVERY Home Buyer Should Know: https://www.madisonmortgageguys.com/fha-guidelines/
- Credit Reports and Scores: https://www.consumerfinance.gov/ask-cfpb/category-credit-reporting/
- Disputing Errors on Credit Reports: https://www.consumer.ftc.gov/articles/0151-disputing-errors-credit-reports