Poor credit borrowers don't have the subprime option anymore, but FHA loans are often a better fit anyway.

The ongoing recession in the U.S. has caused its share of damage, as rising unemployment makes it tough for consumers to meet their financial obligations. If your credit report is looking a little worse for wear, you may have only one home financing option left: the FHA.

Learn about FHA mortgages

A few years ago, the FHA was largely unknown among poor credit and subprime borrowers. At that time, the growing subprime mortgage industry welcomed bad credit borrowers with speedy approvals and generous loan amounts. The FHA, in comparison, could offer, at best, more expensive mortgages that took weeks to process.

Things have changed, and the industry's subprime product has vanished. If you want a mortgage that isn't protected by mortgage insurance, you have to clean up your bad credit first, and then be prepared to fund a 20 percent down payment. At a time when the economic outlook is uncertain, it's tough to drain the last penny from your savings to buy an asset that may lose value-assuming that you have enough cash to do so.

Subprime without the stigma

Other than putting off your home purchase for two years, your next option is an FHA loan. It's actually a pretty workable option, whether or not you have poor credit. Technically, the FHA doesn't fund mortgages; it just insures mortgages that meet its guidelines. You have to pay for the FHA insurance, but you'll benefit from the program's low down payment requirements and more lenient underwriting.

Here's a quick rundown of what to expect from an FHA loan:

 

Low down payment.

The minimum down payment requirement is 3.5 percent of the purchase price. You can even use a gift from a family member to cover this.

 

Emphasis on your ability to pay.

The FHA doesn't use your credit score to determine eligibility. Instead, the underwriting process evaluates your monthly debt payment to your income level. Your mortgage payment should be less than 31 percent of your income, and your total debt payments should be less than 43 percent of your income.

 

Really bad credit may be an issue.

Some lenders independently assert their own credit score minimums on FHA mortgages. If you're declined for this reason, you can always try going through a different FHA-approved lender. A better option is to direct some attention towards cleaning up your credit history as soon as possible.

 

Competitive, but not cheap, pricing.

FHA loan rates are not the cheapest out there, partly because you have to pay for the mortgage insurance. But for poor credit borrowers, in particular, the FHA rates are likely to be pretty competitive relative to other options.

 

A dinged-up credit history doesn't have to ban you from owning a home. Learn more about FHA mortgages at www.HUD.gov

Published on April 1, 2009