James R. DeBoth, President-Mortgage Market Information Services, Inc.
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Once upon a time not too many years ago, having bad or even slightly damaged credit could block you from getting a home loan. Today it just makes it more expensive. How expensive? Subprime” loans, as they are called, can cost from two to six percent above conventional rates, and possibly more. As expensive as this might be, there are some compelling reasons to get a home loan, even at a high rate. You get the tax deductions on the interest rate you are paying on your income tax, and you can establish good credit within a year or two. However, this is not a step to be taken lightly. You must be able to afford to make these higher payments and make them on time or you could face foreclosure or bankruptcy, which would leave you in worse credit shape than you were in before. The less risky route is to clean up your credit before buying a house. By taking care of any problems with your credit report and paying your bills on time, you should be able to establish a good credit rating within a year or two. With your credit cleaned up, you can apply for a mortgage at near the market rate that will be well within your financial parameters. However, if you get that loan at a high rate you will have a home that you will be able to build equity in while you are cleaning up your credit rating. With clean credit, you can refinance a new loan at a lower rate, and you might be able to do that within one or two years. Last, but fiscally far from least, you get to deduct the interest on your mortgage payments from your taxes. Consider the alternatives: a mortgage payment that is building equity in a house coupled with tax-deductible interest versus rent on a place you’ll never own with no tax advantages whatsoever. There are mortgage loans today “that you can qualify for the day after your bankruptcy is finalized or discharged,” says Rick Swartz of Kern County Credit Consultants in Bakersfield, California“. In the past lenders wouldn’t touch you, but now what has happened is that when the first lender lowered the qualifications, the rest had to follow suit, ” he adds. “The market for bad credit is now bigger than the market for good credit.” If you have less-than-perfect credit, you are not alone. Online lender Allied American Mortgage of Brooklyn Center, Inc. says, “It is estimated that over 80 percent of all borrowers have derogatory items on their credit report.
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In order to serve that market, lenders have had to set up standards for determining just how bad someone’s credit is. Each company has its own way of sorting and classifying credit ratings. As a general rule, an “A” rating is someone with no bad marks, late payments, missed payments, collections, liens, or judgments. A “D” rating usually refers to someone with a history of late payments, collections, liens, judgments, repossessions, and maybe even a foreclosure. The #B# and “C” ratings fall somewhere in between.
There also are differences between identical bad credit ratings. Some lenders call them “story loans.* They listen to the “story,” or the reason for the bad credit. For instance, a person might have had a good credit history, but then got laid off, divorced, or hit with a catastrophic medical bill. The “story” loan is also sometimes referred to as a “financial hiccup.’ A person with a good–and provable–story will probably do better than someone who has always had bad credit, i.e., a chronic bad risk.
A person with an A rating could very likely get a mortgage for a house by putting only three percent down and paying the going interest rate. However, someone with a “B* rating might have to make a bigger down payment and pay a slightly higher interest rate. The amount of the down payment required and the amount of interest increase as the credit rating gets worse.
As interest rates climb, they do make the loan a lot more expensive. Here’s an example. A $100,000 loan at 7 percent over 30 years would mean monthly payments of $665.30. This does not include taxes or insurance. If someone actually kept the mortgage for the full 30 years, they would wind up paying off the $100,000 plus $139,511 in interest. Take the same loan at 9 percent and monthly payment at $804.62. The 30-year repayment would be $100,000 plus $189,667 in interest. If you were to take that loan at 13 percent, it would call for a monthly payment of $1,106.20 and a total 30-year repayment of the original $100,000 plus $298,229 in interest.
Of course, hardly anyone keeps a loan for 30 years, especially a high-interest loan. Once you’ve got a year’s worth of on-time payments you can start shopping for a better mortgage rate. That’s what refinancing is for. Once you get your credit rating back into shape by showing that you can and will meet your monthly bills, you can refinance at a lower rate.
So if you think you can afford a big payment for a year or so, it might make sense to go for the subprime loan, since you will be building equity and getting a tax deduction. The key point to remember is that a bad credit rating, like having a cold, is a temporary condition. You can get over it.
Jim De Both is president of Mortgage Market Information Services<a national publisher of mortgage rates & information. Consumers can view additional mortgage information on the internet (http://www.interest.com). END OF STORY James R. De Both is a nationally syndicated financial columnist and is the President of Mortgage Market Information Services, Inc. 01995-2000 Mortgage Market Information Services, Inc. All rights reserved.