It may seem impossible to secure a loan with a bad credit history, but there are a number of ways to finance the purchase of a home using methods that don’t require a conventional lender. The Federal Housing Administration (FHA), for example, offers a number of loan options to potential buyers who want to find the perfect home, but who have issues in their financial history. However, even though there are mortgage loans for bad credit available, buyers should educate themselves on how the process works in order to avoid the pitfalls that can arise.
How It Happens
Most conventional lenders are very hesitant to give a loan to a buyer who has financial issues, like bad credit, because it increases the likelihood of default. Bad credit doesn’t happen in a day. In fact, for some people, it can take years for credit to decline to the point where it damages a credit score. Bad credit happens when there is a foreclosure or bankruptcy, a history of missed payments on borrowed funds, tax liens, poor work history and even a high debt-to-income ratio (meaning more money is paid out than is coming in). An FHA loan is a good option for borrowers with one or more of these issues.
FHA loans and other non-conventional loan types allow for a wide range of people to purchase a home. Typically these loans will have a low interest rate around 3.5%. Lenders are more willing to give a mortgage to someone with bad credit because such loans are guaranteed against default by the FHA.
Although alternative mortgage loans, such as an FHA loan, can make it possible for borrowers with a rough financial history to buy a home, they are not without their pitfalls. FHA loans, like many other types of loans available to people with bad credit, come with some caveats that may make them seem just as restrictive as any other type of loan. For example, an FHA loan will have a much lower limit than a conventional loan. This means that a borrower will not be able to secure a mortgage above a certain amount, which will limit the type, size and even location of a home that can be bought. Additionally, buyers should be aware that mortgage loans for people with bad credit require that the buyer pay out a 1% mortgage insurance premium. This fee will be calculated from the total amount of the loan and must be paid up front. From that point, there will be a monthly premium for several years afterward that must also be paid.
Avoiding the pitfalls of bad credit mortgage loans means understanding how the loan works. Both conventional and non-traditional loan types have benefits and drawbacks. The best type of loan is the one that is a best fit for the borrower’s needs. This will help ensure that the loan is not a burden on the borrower and that the lender will be as protected as possible against a default.