How to Buy a Home with Bad Credit

Editor’s note: Robert Bruss passed away on Sept. 26, 2007. This was one of the last real estate columns he wrote. Inman News is publishing Bob’s last work as a final salute to the nation’s most well-known real estate writer.

If you want to buy a house or condominium, the current buyer’s market means it is a great time to be a buyer. Sellers are eager to sell. Equally important, their real estate agents are anxious because home-sales volume is down in most cities.

Even if you have bad credit, if you have good income you can probably buy a home. Working with a savvy buyer’s agent is the best way to (1) find a house or condo you want to own and (2) then finance it, especially if you are “cash challenged.”

MAYBE YOUR CREDIT ISN’T AS BAD AS YOU THINK. Before shopping for a home, it pays to check your credit reports from all three nationwide credit bureaus, Experian, Equifax and Trans Union. You can get one annual free credit report from each company at www.annualcreditreport.com.

However, those free credit reports will not provide your very important FICO (Fair Isaac Corp.) credit scores. Today’s mortgage lenders look primarily at your FICO score, rather than your credit reports.

FICO scores are based on (1) the length of your credit history (the longer the better so don’t close out your oldest credit cards); (2) the percentage of available total credit currently being used (50 percent or lower is considered good); (3) your on-time payment history; and (4) number of recent credit inquiries (don’t apply for credit within six months before buying a home).

Don’t be fooled by credit scores other than FICO. Most lenders look only at FICO scores, which range from 350 to 850, to determine eligibility.

If your FICO score is 700 or above, you will get the best mortgage interest rate. Between 620 and 700 you should be able to get a home loan, but at a slightly higher interest rate. Below 620, however, each lender has its own rules.

The best place to obtain both your FICO score and all three credit reports is at www.myfico.com. For about $45 you can instantly receive this vital information for home buyers.

Study your credit reports and follow the directions to correct any errors. For example, a few years ago my FICO score was depressed because one credit bureau said I owed unpaid real estate taxes on a property I had sold. Although it was a hassle to get that error corrected, my FICO immediately shot up after that derogatory item was removed.

Each credit bureau has 30 days to “verify” any incorrect information you challenge. If the creditor doesn’t verify a bad report such as a late payment (most don’t reply within 30 days), the credit bureau must remove it from your report. Be sure to check all three reports and ask for corrected copies after 30 days.

CONSIDER GETTING PREAPPROVED IN WRITING FOR A MORTGAGE. If you have a FICO score of 620 or higher, the next step is to get preapproved (not just prequalified) in writing by an actual mortgage lender.

Business is slow now so lenders will welcome your inquiry. Most lenders won’t charge any upfront fee because they know you are likely to come back when you find the house or condo you want to buy with your preapproved mortgage.

Mortgage brokers, mortgage bankers and direct lenders such as banks and credit unions can arrange your preapproval letter or certificate. Despite what you read in the newspapers and hear on TV and radio, mortgage lenders are still eager to make loans.

Just because a lender preapproves you does not obligate you to borrow from that money source. But the lender’s preapproval will show your maximum available mortgage, thus focusing your home search on affordable residences.

Your lender can also help compare mortgage choices, such as VA, FHA, PMI (private mortgage insurance), conventional mortgages and special programs, such as loans for first-time home buyers.

However, don’t be surprised if the preapproval includes reasonable conditions such as (1) a satisfactory appraisal of the home and (2) reverification of your income and credit, just to be sure you didn’t quit your job and buy a new Rolls Royce.

ALTERNATIVES TO OBTAINING A NEW MORTGAGE. If your FICO credit score is low or you don’t have enough cash for a substantial down payment, that’s no reason not to buy a home as long as you have sufficient income. But you will probably have to consider alternative home-finance methods.

Whenever possible, buy from a motivated home seller. Signals of high motivation to sell include job transfer to another city, divorce, unemployment, death or birth in the family, retirement and pending foreclosure. Depending on the situation, here are easy purchase methods to consider if you have bad credit:

1. BUY THE HOME “SUBJECT TO” OR ASSUME THE EXISTING MORTGAGE. Even if the home seller is behind on a few mortgage payments, buying a home by taking over payments on the existing mortgage and paying the missing payments is one of the easiest purchase methods.

For example, suppose you are considering purchasing a $250,000 house that has an existing first mortgage of $200,000 with a monthly payment you can afford. If you have $50,000 for a down payment, that’s great. But if you don’t, offer what you have, such as $15,000, and ask the seller to carry back a $35,000 second mortgage.

Some “subject to” buyers worry the existing mortgage lender might enforce the due-on-sale clause. That is highly unlikely in the current market. If it should happen, however, you can either refinance with another lender or pay a modest assumption fee, typically 1 percent of the mortgage balance, to assume the existing mortgage.

2. LOOK FOR FREE-AND-CLEAR HOMES FOR SALE. At least 40 percent of U.S. homes are free and clear with no mortgage. When these homes come on the market for sale, their elderly sellers often don’t need lots of cash. Instead, they are looking for steady retirement income secured by a mortgage on the home they are selling.

Your buyer’s agent can check listings in the local MLS (multiple listing service) that show zero or low mortgage balances. These homes are ideal candidates for your purchase offer with a 10 to 20 percent down payment and a seller-financed mortgage for the balance. Most sellers won’t bother to check your credit reports and FICO score. But if they do, be sure to emphasize the positives such as your good income.

3. LEASE-OPTION (RENT TO OWN) THE HOME. If the house or condo seller doesn’t need lots of cash but does need a renter to cover the mortgage, property tax, insurance and maintenance costs, a lease-option for one or two years is ideal for both buyer and seller. If you have bad credit, the rental period will give you time to clean up your credit.

A major lease-option advantage for buyers is the rent credit toward the purchase price. As an owner, I usually give a 33 percent rent credit. For example, if a house rents for $1,500 per month, a $500-per-month rent credit is fair to both parties. It’s like a “forced savings account” for the tenant-buyer.

To find lease-options, look in the “houses for rent” and “houses for sale” newspaper classified ads. When you inspect a house for rent that you would like to buy, ask the owner, “If I lease this house (or condo), will you give me an option to buy it?”

Because many landlords will gladly sell, you can create your lease-option on terms you like. More details are in my new special report, “How to Profit from Lease-Options (Rent to Own) If You are a Property Buyer, Seller or Realty Agent,” available for $5 from Robert Bruss, 251 Park Road, Burlingame, Calif., 94010, or by credit card at 1-800-736-1736 or instant Internet delivery at www.BobBruss.com.

(For more information on Bob Bruss publications, visit his
Real Estate Center
).

Copyright 2007 Inman News

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