How To Prepare For An FHA Loan With Bad Credit
In this blog, we will discuss and cover how to prepare for an FHA loan with bad credit. FHA loans are the most popular loan program for borrowers with credit scores down to 500 FICO and bad credit. Borrowers with outstanding collections and charged off accounts can qualify for FHA loans without having to pay outstanding balance. There are many techniques the team at Gustan Cho Associates can help homebuyers with bad credit on how to prepare for an FHA loan with competitive mortgage rates. In the following paragraphs, we will cover and discuss how to prepare for an FHA loan with bad credit.
What Are FHA Loans?
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What Determines Mortgage Rates on FHA Loans?
Credit scores have the biggest impact on FHA mortgage rates. There are ways of boosting credit scores quickly. Experienced loan officers can guide borrowers on ways of increasing their credit scores quickly. We will cover on how to increase credit scores in this article In the following paragraphs, we will discuss and cover how to prepare for an FHA loan with bad credit at the best mortgage rates.
The higher the risk a lender takes with a borrower, the higher the mortgage rates they charge. Higher risks mean higher rewards. There are various loan level pricing level adjustments lenders charge for layered risks. However, credit scores are the biggest factor when it comes to mortgage rates. The higher the credit scores, the lower the mortgage rates. Borrowers who are focused on getting the best mortgage rates should try to boost their credit scores prior to applying for a mortgage.
For individuals with poor credit, an FHA loan is one of the most recommended options because of these important factors:
Buying a House with Bad Credit and Lower Credit Score Requirements
- Credit scores of 580 or above are accepted for an FHA loan with a down payment of 3.5%.
- Some lenders may also accept credit scores 500 with a 10 % down payment.
- They also forgive scores less than 620, a typical requirement for conventional loans.
More Lenient Qualification Standards
- They are generally more lenient with credit flaws such as bankruptcies and foreclosures.
- Chapter 7 bankruptcy: 2-year waiting period (compared to 4+ years for conventional).
- Foreclosure: 3-year waiting period (compared to 7 years for conventional loans).
- Debt-to-income ratios are more easily accepted and are higher (often up to 43-45%, and sometimes higher).
- Wide credit history manual underwriting is available for borrowers with limited credit history.
Buying a House with Bad Credit with Competitive Interest Rates
- The risk posed to lenders is less because of government backing.
- Even though they have lower credit requirements, lenders’ rates usually equal conventional loans.
Buying a House with Bad Credit with Stable Financing Terms
- Fixed-rate options come with predictable payments.
- There are no prepayment penalties.
- No balloon payments.
Consistent Guidelines
- Standardized FHA guidelines mean lower approval process variations compared to non-FHA loans.
- Compared to non-FHA loans, there is less differentiation in the standard eligibility requirements set by FHA.
- But there are some cons with FHA loans:
- Mandatory mortgage insurance for the life of the loan (in most cases)
- Upfront mortgage insurance premium (1.75% of the loan amount)
- The property is required to meet certain conditions.
- Conventional options may have lower cap limits in high-cost areas.
- For people with credit issues, loans through FHA are almost always the easiest option for owning a home. However, the specifics differ for every person.
Benefits 9f FHA Loans When Buying a House With Bad Credit
- Over 40% of homebuyers use FHA loans when they purchase a home
- HUD, the parent of FHA, is the government agency that sets guidelines on FHA home mortgages
- HUD is not a lender
- It is a government agency that insures and partially guarantees lenders if borrowers default and foreclose on their FHA loans
- Due to the government guarantee, lenders can offer FHA loans with only a 3.5% down payment and a 580 credit score
- HUD’s role and mission are to promote homeownership to first time home buyers and home buyers with less than perfect credit
- Homebuyers with prior bad credit and lower credit scores can now have a chance to buy a home
- Homebuyers with a prior bankruptcy, foreclosure, deed in lieu of foreclosure, or short sale can qualify for an FHA loan after meeting the mandatory waiting period requirements
In this article, we will discuss and cover the benefits of FHA Loans to Purchase New Home With Bad Credit.
Buying a House with Bad Credit with an FHA Loan versus Other Loan Programs
There are various mortgage loan programs for borrowers to choose from.
- The loan officer will go over the best loan program available for borrowers
- FHA loans are a very popular home mortgage program due to its lax lending guidelines
- FHA loans are perfect for first-time home buyers due to the low down payment requirements and lenient credit requirements
- FHA requires a 580 credit score for borrowers to qualify for a 3.5% down payment home purchase FHA loan
- Borrowers with under 580 credit scores and down to 500 FICO are eligible for FHA loans with a 10% versus a 3.5% down payment
- Conventional loans are not government-backed home mortgages
- The minimum down payment on conventional loans is 3% to 5%
- The minimum credit score requirement on conventional loans is 620 FICO
- VA loans are government loans that offer 100% financing with no down payment and no mortgage insurance premium
- However, VA loans are only for active and/or retired members of the United States Armed Services with a certificate of eligibility (COE)
- USDA Loans are government loans that offer 100% down payment
- However, only select homes in certain rural areas are eligible for USDA financing
However, conventional mortgage rates are substantially higher for lower credit score borrowers than FHA loans.
Types of Homes You Can Purchase With FHA Loans
Only owner-occupant primary residence homes are eligible for government loans. This holds true on FHA loans.
Here is the type of properties that qualify for FHA financing:
- Detached single-family homes
- Townhomes and PUDs (Planned Development Units)
- Condominiums (FHA loans are eligible for HUD-Approved Condo Financing)
- Two to four-unit multi-family homes
Second homes and investment properties cannot be financed with FHA and/or other government loans. If a condo complex is not FHA approved, HUD now allows FHA Spot Loans. FHA Spot Loans enable condo buyers to purchase a condominium unit in a condo complex that is not HUD-approved.
Mortgage Rates on FHA Versus Conventional Loans
One of the most frequently asked questions we get daily at Gustan Cho Associates is does prior bad credit have an impact on mortgage rates? The answer is NO. A prior bankruptcy, foreclosure, deed in lieu of foreclosure, short sale have no impact on mortgage rates. Late payments have no bearing on mortgage rates.
Outstanding collections and charged-off accounts have no impact on determining mortgage rates. However, there are loan level pricing adjustments or pricing hits that lenders will charge when determining mortgage rates. We will discuss the topic of how lenders determine mortgage rates on FHA loans.
How Do Lenders Determine Mortgage Rates On FHA Loans
How To Prepare For An FHA Loan for borrowers should start months before applying for the loan. The best way on How To Prepare For An FHA Loan with the best rates is to boost your credit scores. There are quick fixes in maximizing your credit scores. There are a few factors on how lenders price out mortgage rates.
The number one impact on mortgage rates is credit scores. The higher the borrower’s credit scores, the lower the mortgage rates. Any layered risks the lender takes on, there is a pricing adjustment on that hit. Not all lenders have the same pricing hits on layered risks. One lender may have pricing hit on high debt to income ratios and a different lender may not.
Loan Level Pricing Adjustments On FHA Loans
The following factors play a role in how lenders determine mortgage rates on FHA loans:
Credit Score:
- Credit scores have the biggest impact on how lenders determine mortgage rates
- The lower the credit scores, the higher the mortgage rates
Down Payment And Loan To Value:
- The lower the loan to value, the lower the mortgage rates on conventional loans
- However, on FHA, VA, USDA loans, the loan to value has no impact on mortgage rates due to the government guarantee
- Therefore, there are no pricing adjustments on FHA mortgage rates on the amount of down payment
Debt to Income Ratio:
- Most lenders will have a pricing adjustment for borrowers with higher than 50% DTI
Manual Versus Automated Underwriting System:
- Lenders normally charge a pricing hit on manual underwriting
Loan Size:
- Lenders will have pricing hits on the loan size
- Smaller loan sizes under $200,000 will have a pricing hit
- High-balance FHA loans will also have a pricing hit to the rate
Multi-Family Homes And Types Of Property:
- The type of property will have an impact on rates
- There are no pricing hits on single-family homes
- Condos and multi-family homes are considered riskier investments so there are pricing hits
- Manufactured homes are considered riskier investments by lenders so rates are higher
Type Of Loan Program:
- There are various types of FHA loans
- There are different pricing adjustments on FHA 203k loans, FHA Jumbo loans, FHA Streamline Refinance, FHA One-Time Construction loans, Reverse Mortgages
Location of the property:
- Lenders can have pricing hits in properties located in a certain area
- For example, mortgage rates in a property in California can be higher due to earthquakes
- Mortgage rates in a property in Florida can be higher than rates in homes in Illinois because of hurricanes
- Homes in declining housing markets can be higher than areas where homes have a history of appreciation
Escrows:
- Mortgage rates on conventional loans without escrow accounts are normally a little higher than rates with escrow accounts
- However, escrows are required on all government loans
- Therefore, there are no pricing adjustments on escrows when it comes to FHA loans
As mentioned earlier, prior bad credit such as bankruptcy, foreclosure, deed in lieu of foreclosure, short sale, outstanding collections, charged-off accounts, and other derogatory credit tradelines have no impact on mortgage rates.
Tips On How To Prepare For An FHA Loan By Increasing Credit Scores
The best tip on how to prepare for an FHA loan is by paying down credit card balances, get new secured credit cards, and by adding yourself as an authorized user on a family member or close friend’s credit card. Adding yourself as an authorize user needs to be done with caution. Make sure the main user has perfect payment history and a low credit card balance.
It is no rocket science in boosting your credit scores. The team at Gustan Cho Associates has helped countless consumers boost their credit scores so they can qualify for a mortgage. The best and quickest way to boost your credit scores is by having three credit cards with at least $500 credit limits. Consumers without a credit card and bad credit can start re-establishing credit by getting three secured credit cards with at least a $500 credit limit.
Many Americans who have filed bankruptcy can get credit scores higher than 700 FICO by getting three secured credit cards with at least a $500 credit limit and one installment loan. Installment loans are car loans or other loans where consumers make monthly payments. A great installment credit builder is www.self.inc.
It is best-recommended borrowers to prepare for a mortgage a few months prior to applying by boosting their credit scores. If you need help in boosting your credit scores, feel free to contact us at Gustan Cho Associates at 800-900-8569 or text us for a faster response. Or email us at gcho@gustancho.com. The team at Gustan Cho Associates is available 7 days a week, evenings, weekends, and holidays.
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Buying a House with Bad Credit with an FHA versus Conventional Loans
Conventional loans are ideal for homebuyers with higher credit scores, lower debt-to-income ratios, and higher down payments.
Below is a comparison between FHA versus conventional loans:
- FHA allows a front debt to income ratios up to 46.9% and back end DTI of up to 56.9% to get an approve/eligible per automated underwriting system (AUS)
- The maximum debt-to-income ratio allowed on conventional loans is 50% DTI
- There is no front end debt to income ratio requirements on conventional loans
- Both FHA and Conventional loans allow non-occupant co-borrowers
- FHA requires non-occupant co-borrowers to be related to the main borrower by law, blood, or marriage
- FHA allows non-occupant co-borrowers who are not related by the main borrower by blood, marriage, or law, but then the down payment requirements are 15% down payment versus a 3.5% down payment
- There is no relationship requirement on blood, law, marriage on conventional loans
- FHA requires a one time upfront 1.75% mortgage insurance PLUS a 0.85% lifetime annual mortgage insurance premium for the life of the 30-year fixed-rate mortgage loan
- Conventional loans do not require any private mortgage insurance for borrowers with at least an 80% loan to value
- Private mortgage insurance is required on conventional loans if the property has less than 20% equity
- Private mortgage insurance can be requested to be canceled on conventional loans if the homeowner’s equity position in their home exceeds 20%
A loan officer can compare the benefits of using FHA loans versus conventional loans for a borrower.
Buying a House with Bad Credit: HUD Guidelines versus Conventional Loans
Below is the list of HUD Agency Lending Guidelines on FHA versus Conventional Loans:
- 3.5% down payment with a minimum 580 credit score requirement on FHA loans
- Conventional loans require 3% down payment for first-time home buyers
- Otherwise, it is a 5% down payment
- First-time homebuyers are those who had no ownership in a home for the past three years
- FHA requires a two-year waiting period after Chapter 7 bankruptcy discharge date
- Conventional loans require a four-year waiting period after Chapter 7 bankruptcy discharge, short sale, and foreclosure
- HUD requires a three-year waiting period after foreclosure, short sale, deed in lieu of foreclosure to qualify for FHA loans
- Fannie Mae and Freddie Mac require a seven-year waiting period after a foreclosure to qualify for conventional loans
- FHA and VA loans allow borrowers in Chapter 13 Repayment plan to qualify for home mortgages after making 12 months timely payments with Trustee Approval
- Chapter 13: Bankruptcy does not have to be discharged and needs to be a manual underwrite
- There are no waiting period requirements after Chapter 13 Bankruptcy discharged date
- Any Chapter 13 Bankruptcy that has not been discharged for at least 2 years needs to be manually underwritten
- Manual underwriting guidelines apply
FAQ’s Buying a House with Bad Credit
This is a set of Frequently Asked Questions (FAQs) aimed at simplifying the process of purchasing a house with bad credit. Every question considers options, actions, and critical thought, hence the detailed answers.
Q1: Is it possible buying a house with bad credit?
A: It is possible. Although bad credit restricts some traditional financing routes, plenty of alternatives and government-backed loans, such as FHA loans, are specifically for buyers with subpar credit. Nevertheless, you might have to pay higher interest rates and require a larger down payment.
Q2: What credit score makes obtaining a mortgage difficult?
A: Most credit channels will deem anything below 620 as bad credit. Admittedly, some lenders and loan programs have specific requirements which could impact the results. Government-funded loans usually have lower thresholds on credit score benchmarks than conventional loans.
Q3: What are some available financing options for buying a house with bad credit?
A: Examples include:
- FHA Loans — Subsidized by the government with a lower minimum credit score mandate.
- VA Loans Tend to be more forgiving of credit criteria, so if you’re a veteran or active-duty military personnel, you qualify.
- USDA Loans: These loans may be an option with flexible credit criteria for buyers looking in rural or suburban areas.
- Subprime or Non-Prime Loans: Some lenders typically offer these to borrowers with low credit scores, but they may have higher interest rates and fees and are considered non-prime.
- Seller Financing: The seller may finance the property directly, which can sometimes be more flexible than other forms of lending.
Q4: What is the best way to improve my credit before applying for a mortgage?
A: Consider these steps:
- Review Your Credit Report: Check for any inaccuracies and resolve them.
- Pay Off Existing Debt: Aim to eliminate high-interest debt and maintain low credit card balances.
- Make Payments on Time: Create an on-time payment history for all bills.
- Don’t Take On New Debt: Avoid opening new credit accounts during the improvement timeframe.
- Consult A Credit Professional: A credit counselor can help you develop a plan for your financial needs.
Q5: Should I pay more upfront if I have low creditworthiness?
A: Most of the time, yes. With a lower credit rating, the risk of extending credit increases, which means a greater down payment is usually required. For FHA loans, the minimum is usually 3.5 percent of the total purchase price. Still, some lenders will want more if the credit is awful.
Q6: Buying a house with bad credit: Can I get a mortgage with bad credit if I have a co-signer?
A: Yes. The chances of loan approval rise significantly with a co-signer with good credit history. In addition to the better terms, there’s a good chance of obtaining better rates. However, the co-signer bears the responsibility of repaying the loan if you do not honor your part of the deal, so take caution with this option.
Q7: Buying a house with bad credit: Do first-time home buyer loans for bad credit exist?
A: Numerous local and state programs are focused on assisting novice homebuyers, regardless of their credit score. These programs include aid covering part of the initial payment, unique financing terms, or even outright gifts. Check with local housing agencies or a financial advisor to uncover what options you can avail yourself of.
Q8: What should I do before purchasing if I have low credit?
Answer:
- Evaluate Your Finances: Know your limits and determine your budget.
- Improve Your Credit: Follow the abovementioned steps to increase your credit score.
- Get Pre-Approved: Talk to different lenders to explore options and get pre-approval for a mortgage.
- Budget for Additional Costs: Account for additional costs such as increased interest rates, larger down payments, or mortgage insurance.
- Consult a Professional: Partner with a financial consultant or a mortgage broker who assists buyers with poor credit.
This FAQ attempts to cover the most relevant information regarding purchasing a house while managing bad credit. As always, everyone’s situation is unique and specific. Consulting a specialized expert can make the client’s decision easier and more rational based on their circumstances.
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