All is not lost just because you have bad credit. There are certain companies specializing in bad credit mortgage loans that will help you not only reenter the real estate market, but also improve your overall credit and financial stability. However, you must make it your business to avoid the problems that sometimes plague individuals with bad credit who are in a mortgage. Here are seven expensive mistakes to avoid in this situation.
1. Am I making myself house poor?
People with bad credit who max out their preapproval loan amount may end up with all of their net worth in the house. This does not bode well for paying down any of the other debts that are helping to create bad credit for you. In general, if you are spending more than 28 percent of your gross monthly income on the mortgage payment, then you need to scale down: For instance, a person who is earning $75,000 a year should not spend any more than $1750 a month on mortgage payments, insurance, and homeowner’s association (HOA) fees. Use a reputable, free online mortgage calculator to estimate your overall costs.
2. Am I ignoring the real cost of owning a home?
In order to improve your credit using real estate, you must have a home that maintains its value. This means that you will need enough money to handle routine maintenance on the house. Usually, this number comes out to about two percent of the purchase price of the home per year. If your home is older, this number may go up.
Some of the other costs of owning a home include property taxes and special insurance packages that you may be responsible for holding. These are necessary expenses; however, they do not add to your equity or provide you any direct utility. Make sure that you have enough left over after your mortgage payment to pay these costs.
3. Did I accept the first offer that I got?
Just because you have bad credit does not mean that you have to accept the first mortgage loan offer that you get from a lender. As a matter of fact, you should spend more time making lenders compete for your business. According to the Consumer Financial Protection Bureau, 75 percent of lenders will fill out only one loan application. Comparison shopping is not only smart business, but it will also introduce you to new bankers who may have additional solutions to your credit problems.
4. Am I making my underwriting decision based solely on the annual percentage rate (APR)?
Many lenders will draw in bad credit borrowers with low initial interest rates. However, the bank makes up its upfront money in fees, clamping down the bad credit trap as it raises the introductory rates a few months or years later. Higher origination fees, mortgage point charges, and closing costs can make a lower APR look quite enticing, but upon a proper comparison, a higher APR with lower fees actually comes out better for a borrower. You must also check the fine print of any adjustable rate mortgage that you are considering to ensure that it has a cap on the maximum rate that you can be charged.
5. Do I have cash on hand for a high down payment?
You should have at least 20 percent of the total home price in cash ready for your down payment. This money should be separate from your six-month emergency fund of living expenses. The primary reason that you want 20 percent down is to avoid the private mortgage insurance (PMI) payment, but this is not the only reason.
The higher your down payment, the lower that you can negotiate your interest rate to be. You may also be able to avoid some of the fees that are associated with government-sponsored entity (GSE) loans. The immediate equity that you gain through a down payment will also work wonders for your credit score and give you leverage that you may be able to use to pay down some of your other debts.
Try to improve your down payment to 50 percent if you can, especially if you have bad credit that you are trying to improve.
6. Have I fixed my credit report yet?
Too many people consider Experian, Equifax,, and TransUnion the final authority on their financial health. Just because something shows up on one of these credit reports does not make it true. Challenge everything on your credit that is weighing it down. Force your creditors to prove that you owe money to them. Hopefully, you have the time to check and fix your credit a year before you walk into any banking institution. Although fixing your credit takes time, it is always worth the expense, especially if you are trying to repair your credit for a large asset purchase.
7. Am I using all of my GSE options?
If you qualify for a loan that is insured by the United States Department of Veterans Affairs (VA), then you would be a fool to not take it. The same goes for loans that are insured by the Federal Housing Administration or the Navy Federal Credit Union. These government entities can help to raise your risk profile and subsidize you if you have bad credit.
2 Point Highlight
In general, if you are spending more than 28 percent of your gross monthly income on the mortgage payment, then you need to scale down: For instance, a person who is earning $75,000 a year should not spend any more than $1750 a month on mortgage payments, insurance, and homeowner’s association (HOA) fees.
The immediate equity that you gain through a down payment will also work wonders for your credit score and give you leverage that you may be able to use to pay down some of your other debts.
