Buying a Home with Bad Credit

If you want to buy a home, but have bad credit, you are in a very tough situation. However, home ownership is still possible.

On average, most people in the US now carry about $8,000 in credit card debt. Bankruptcy rates have soared. Credit counselling agencies have lots of business. So, if you are in this situation you are not alone.

Unfortunately, if you have filed for bankruptcy it stays on your credit history for 10 years. This can significantly lower your credit score. If you can avoid bankruptcy by working with a credit-counselling agency, it's usually your best bet. Be sure to pick a reputable one. Not all agencies are as good or have the best programs.

Having said that, you still want to buy a house. So, what do you need to know?

Mortgage lenders increasingly use credit scores to decide who is creditworthy. What is your credit score? Your credit score is a number, which is represents your credit situation as a ranking. If you do not know your credit score you can get a credit report for about $35. It may also be called a FICO score. Fair Isaacs is the company that invented the FICO score and this particular credit score is used by about 70 percent of U.S. mortgage lenders.

If you have a FICO score of 720 or higher, you'll qualify for the best loan programs and interest rates. This can save you thousands over the life of a mortgage. Let's take a look at an example: a score of 720 or higher would qualify for a loan with the best interest rate. A credit score of 700 would qualify for a loan at about percent higher than the best rate. A credit score of 680 would just qualify for a loan at percent higher than the best rate.

What does this mean in terms of monthly payments? On a $200,000 loan, a loan at percent higher would cost about $100 more per month and result in $28,000 more paid by you over a 30-year loan. That's a lot of money.

As you would expect, the interest rates only get higher as your credit score goes down. So what do you do?

Here's the good news: Interest rates are at historic lows. Even the rate that you get with poor credit is pretty good, compared with the interest rates over the last 40 years. Even with bad credit on a first mortgage you are likely to get 8 percent or better.

However, if you have credit problems your second challenge is likely that you don't have much (if any) down payment. That means that you'll need 100 percent financing for your home. That means a second mortgage.

You'll find that a second mortgage will often have a much higher interest rate than a first mortgage. That means that your second mortgage could have an interest rate over 10 percent. If so, your costs of borrowing become pretty high.

Supposing you could afford those kinds of payments, should you do it? It depends on whether the property is a good investment and you can handle the payments on it comfortably. A financial problem could be disastrous in this scenario.

You have options. If you think you can clear up your credit record sufficiently in 2 or 3 years and have a decent place to live in the meantime, you might want to wait. This will give you a chance to both save some money for a down payment and allow you to qualify for lower lending rates later. The money that you would be paying in high interest rates now could become down payment for a property later.

If you are in this situation, talk to a credit counsellor or financial advisor. You'll want to consider the situation very carefully. Most financial advisors will give you some free advice on a first visit. It could be a very valuable investment in your financial future.


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