Low-credit score loans

You can still get a good rate on your mortgage with less-than-perfect credit with an FHA loan.

A mortgage is a major expense. But it can be even more costly when your credit score is less than perfect as you may end up being charged a higher interest rate for a subprime mortgage.

How do you avoid having to pay a higher rate? One way is to pay down your debt, and establish a good track record of paying your bills on time. But it can take up to a year to show results.

There is another way, however, and that’s to consider an FHA (Federal Housing Administration) mortgage. These loans use different criteria than other mortgages, and that may allow lenders to offer you terms only slightly higher than market rates -- in some cases, as little as .125 percent higher.

FHA mortgages
It’s important to understand what an FHA mortgage is. Contrary to some people’s belief, the Federal Housing Administration is not a lender. It is a federal government agency that guarantees loans by private lenders, making mortgages available to people who may have a difficult time qualifying , often because of a lack of credit history. This includes recent college graduates, newlyweds, as well as people who have had credit problems including bankruptcies and foreclosures. Since an FHA mortgage is government-insured, lenders granting these mortgages assume less risk than they do with other low credit score loans and therefore can extend credit at a more reasonable interest rate.

How to qualify
The qualification criteria for an FHA mortgage are different than they are for a conventional loan. While your credit score is usually the most important factor lenders consider when approving you for a conventional loan, with an FHA loan it’s not the central consideration. Rather, the FHA looks at your overall credit history, and is often more flexible in considering mitigating factors.

That doesn’t mean you don’t have to get your credit under control. The FHA requires a one-year period of acceptable credit, during which you have made all your payments promptly. It may review your rental or mortgage payment history during that time, any new credit or credit inquiries, and whether you have paid off any judgments against you. And it considers your debt-to-income ratio to ensure you’ll be able to repay the loan.

Advantages

• The FHA may not hold an unpaid collection against you if there is a valid reason for not paying it.
• You can qualify three years after a foreclosure, as opposed to the usual four years with a conventional loan.
• Your down payment can be as little as 3 percent of the loan amount.
• The down payment can be a gift from a family member, government agency or non-profit organization.
• Your housing expenses (PITI) and other debt payments can total 41 percent of your income, compared with the usual 33-36 percent for a conventional loan.

Disadvantages

• There is a limit to the amount you can borrow that varies depending upon your area.
• You may have to take out a second loan if, due to regional limitations on the amount your can borrow, an FHA loan does not provide you with sufficient financing. (On a $100,000 mortgage, the 1.5 percent upfront mortgage insurance payment would be $1,500 which, wrapped into a fixed, 30-year mortgage at 8 percent, would come to an additional $11.01 per month. The 0.5 percent annual premium would be $500 per year or $41.67 per month.)

While an FHA mortgage may be the answer for you, not all FHA mortgages are the same. So look carefully at the rate and other features, and compare FHA mortgages from different lenders before you sign.

Related Topics:

• Down payments
• Interest rates
• Mortgage Refinance
• Mortgages