Bad Credit Loans Made Easier by Pre-Approval
(Updated November 2014)
Imagine the indignity of finding your dream home, having your offer accepted by an eager seller, and then having the lender say, "No!" You end up upset and embarrassed. The seller gets angry that you tied up his home. Worst of all, you may lose the contract.
You can avoid all this by getting pre-approved for a mortgage. It's even more important to seek pre-approval if your credit history is bad.
What is bad credit?
The definition of bad credit has changed over time. Prior to the recent crash, you could get a mortgage with just about any type of credit, though you might pay a higher rate if your FICO score was in the 600s or lower. But just about any credit score over 700 was considered ideal.
These days, lenders are much tighter with credit. The cutoff for excellent credit is a FICO of 740 or more, and anything under 700 is considered weak. Scores of 640 or below are simply bad and anything in the 500s is awful - though certain lenders will still approve mortgages in that range, though you'll pay a steep interest rate and need a hefty down payment.
If you've got weak or bad credit, your best bet might be to seek an FHA home loan, which allows lower credit scores than the more popular "conforming" loans backed by Fannie Mae or Freddie Mac. The average credit score on Fannie/Freddie mortgages is currently around 740, so if your score is 680 or less, you may have trouble getting approved.
On FHA loans, however, the average score is around 680 and some major lenders will approve bad credit FHA loans on scores as low as 600. Some specialty lenders will do FHA loans even into the mid-500s.
VA loans also have more generous standards when it comes to poor credit than standard Fannie/Freddie loans do. And beyond that, bad credit borrowers can also seek strictly private market loans that have no minimum credit score, but are generally more costly than more conventional loan types.
Regardless of the loan program you go with, getting pre-approved will let you know how much you can borrow and at what interest rate and terms before you begin shopping for a home.
Pre-approval is not the same as pre-qualification. It's important to keep the two of those straight. While pre-qualifying can be helpful, it doesn't carry anywhere near the same clout as getting pre-approved for a loan.
Pre-qualification is generally the first step in shopping for a home and seeking a mortgage. In simplest terms, it's a way of obtaining a ballpark estimate of how much you'll be able to borrow with a mortgage.
To pre-qualify for a bad credit loan, you'll need to provide information about your income, your total debt, and your assets. The lender will then review those numbers and estimate the amount of the loan for which you would qualify. The lender, however, is not obligated to lend you the money until the information that you provide is verified.
Pre-qualification is helpful in that it lets you identify the price range of the homes you might be able to afford so that you can begin shopping around and identifying suitable neighborhoods. It can also be useful in identifying things you may need to work on before buying a home, such as saving more toward a down payment or reducing debt before buying.
Although pre-qualification is free and can give you an idea of how much you can afford to spend on a house, pre-approval gives you a financial foundation, much like your house's foundation.
Pre-approval is a more rigorous process, and as a result is a more reliable guide to whether you can actually obtain a loan for a certain amount. With a pre-approval, a lender is no longer estimating, they are actually telling you they will lend you a certain amount of money on certain terms, provided you can find a suitable home.
This can be a persuasive piece of information to a seller, who won't have to worry about whether you'll be approved for financing and if you're able to complete a deal. Pre-approval can also speed up a closing because the lender has already done a lot of the legwork needed for the final loan commitment.
Before a lender will pre-approve you for a bad credit loan, your credit and income information must be verified. A small fee is usually charged for this service, and once you're approved, you'll receive a letter that states the loan amount and the length of time that the offer will remain open.
It's important to remember that pre-approval doesn't mean you're guaranteed to be approved for a mortgage on any home you choose. The property itself will have to be assessed and found to be valuable enough to support the sales price you've agreed to.
If you're looking for a bad credit mortgage, taking the time to get pre-approval can both save you the worry and embarrassment of being turned down for a mortgage, and get you into your new home much faster.