Debt Free

If you want to leap into the ranks of the homeowners but are a wee bit credit challenged, all is not lost. There are mortgage options available to you, even with your bad credit. Be advised, however that due to the recent problems in the sub-prime mortgage market, lenders are tightening their requirements for mortgage lending. Does this mean that you’ll have to give up on your dream of home ownership? Not at all; there are still options available to you, here are a couple of them.

Bad Credit Mortgage Option – The 2/28 ARM
Chances are one of the first options your mortgage broker will trot out for you is something called a 2/28 ARM. This is an adjustable rate mortgage whose interest rate is fixed for the first 2 years (the number before the slash in ARM notation is always the number of years for which the interest rate is fixed), then adjusts upward according to an index. The interest rate you’ll pay is the index rate plus what’s called a margin. Make sure you’re well aware of what that is and how it will affect your future payments.

2/28 ARMs usually have a  2 year prepayment penalty, meaning you’ll be unable to refinance for the first 24 months of the loan without paying a stiff one to the lender. That’s probably okay, as you’ll use this time to rebuild your credit so you’re able to qualify for a better loan. The prepayment penalty can make a huge difference in how you proceed in the future however, so it’s vital to verify the terms of the penalty, if it exists.

2/28 ARMs are known in the industry as ‘B’ paper loans, denoting their lower credit requirements than ‘A’ paper loans. Something to watch for with this, or any ARM, but especially those targeted at the sub-prime market is the interest rate cap. They can be quite high, and if you keep this mortgage beyond the initial 2 years, you could (and probably will) see the monthly payment escalate substantially, especially if the indices used by lenders , such as the FED prime rate or LIBOR, continue to rise.

Bad Credit Mortgage Option – FHA loan
If you have a history of poor credit, but are on your way to recovery, you may be able to take advantage of the FHA loan. The FHA loan is a fixed rate mortgage. FHA loans are federally insured, reducing the risk to the lender and allowing the homebuyer to get a mortgage they would perhaps be unable to qualify for. This program was started by the federal government in 1934 to help would-be homeowners stung by the Great Depression. FHA stands for Federal Housing Administration. It’s part of an even larger government agency (there are so many), the Dept. of Housing and Urban Development (HUD).

The FHA is attractive for first time homebuyers due to the low down payment of 3%. FHA loans are also available for manufactured homes and mobile homes. The credit requirements of FHA loans are somewhat more relaxed than the requirements for a normal mortgage. You need a stable income and employment history for the past two years. If you’ve had a bankruptcy, it must be at least 2 years since the discharge date and a foreclosure must be at least 3 years behind you. You must have fewer than 2 30 day late payments in the previous 2 years.

In some areas of the country an FHA loan will be unable to secure a home for you, due to the 30% mortgage payment / income guideline. If you make $60,000 annually, you’ll be looking at a house payment of $1,500/ month. If you live in Boston, New York, Seattle or LA, that’s a stretch for a 3 bedroom / 2 bath home. In these and some other locales, such homes are typically well over $300,000. (in King County Washington for example, only 14% of homes on the market are less than $300,000). That’s great if you bought one a few years ago, not so good if you’re looking to get into such a home now.