(Updated Oct. 2014)
If you've had credit problems, the world of mortgages may seem like an exclusive club, where bouncers stand between you and your financial future. Fortunately, after largely drying up for a few years, the availability of subprime loans is increasing again.
The subprime loan, also called a bad credit loan, is specifically for borrowers with spotty credit. Lenders may advertise them as "another chance mortgages" or "alternative mortgage programs." The key to making a bad credit mortgage work in your favor is knowing how to select a subprime lender.
What is a subprime mortgage? The credit data firm Equifax defines it as a home loan given to a borrower with a FICO credit score of 660 or below. Other definitions may vary slightly, but basically it's a home loan with a significantly higher interest rate and down payment requirements to offset the higher risk of default by the borrower.
Four key tips
Selecting a reputable subprime lender can be your first step to repairing your credit and securing your financial future. Those bouncers at the mortgage loan door aren't keeping you out; they're just directing you to another entrance.
Here are four essential tips to help you select a subprime lender:
- Compare terms and fees. Ask at least three prospective lenders to provide you with the terms, and a complete list of fees, in writing. Review and compare this information carefully.
- Be concerned with prepayment terms. You want to have the option to refinance your mortgage with a less expensive, traditional program, as soon as you can qualify. If the prepayment period and fees are excessive, you could be locked into your subprime loan longer than you want to be.
- Be cautious about upfront fees. Reputable lenders don't normally request upfront loan fees. The only fee you should be charged upfront is a nominal credit application fee. Excessive charges payable before loan funding may indicate that the lender is trying to take advantage of you.
- Assess your lender's character. Never allow a lender to pressure you into borrowing more, overstating your income, or signing an agreement that isn't completely filled out. These are signs that the lender isn't concerned with your realistic ability to repay the loan.
What are your options?
One of your best bets for a subprime mortgage may be through an FHA program. Some lenders, including major ones, will approve such loans for borrowers with FCIO scores as low as 600, and perhaps beyond.
FHA loans are attractive to lenders because they're insured against default and lenders can bundle them into securities for sale to investors. That may mean a lower interest rate and smaller down payment than you'd have to pay on a subprime loan without agency backing.
The common assumption is that you can't get a mortgage with poor credit. In reality, the bigger challenge may be finding a mortgage you can afford. There are lenders out there who will write mortgages for borrowers with credit scores in the 500s and even upper 400 range, but those borrowers are making down payments of 30-40 percent and paying interest rates as high as 9-11 percent on a 30-year loan.
When seeking a subprime loan, you may have better luck working with specialized lenders who specialize in doing loans the big lenders won't touch. They need to find a niche to compete in the lending marketplace and subprime loans offer that opportunity.
Refinancing to better terms
Note that taking out a high-interest rate subprime mortgage doesn't mean you're locked into that for the life of the loan. If you don't miss any mortgage payments and stay current on any other debt payments for three years or so, you should see an improvement in your credit score that may allow you to refinance on better terms.
The most important thing to remember when researching subprime loans is that you are not subprime. A lender that makes you feel like you have no choice but to accept high fees and restrictive terms is a lender you should avoid. The legitimate lender's primary concern will be your realistic ability to make the loan payments as scheduled.