Buying a house does not have to wait for you to earn perfect credit. It also does not have to wait for you to save all the money to buy it outright. You can still obtain bad credit mortgage loans. The financial communities refer to this as a Subprime Mortgage Loan.
Subprime Mortgage Loan For a Low Credit Score
Subprime mortgage loan refers to a loan extended to a borrower with a higher risk than those referred to in the financial term “prime” which refers to the lowest risk borrowers.
A prime borrower provides a low risk because she has a high credit score, a low debt load, and a healthy income. These factors indicate the prime borrower can easily cover the monthly loan payments. A subprime borrower has characteristics such as a lower credit score, a higher debt load and may have a lower income.
A glut of subprime mortgage loans to bad credit borrowers contributed to the mortgage crisis of the mid-2000s. These higher-risk borrowers did default on their loans, creating fiscal issues throughout the finance industry.
This did not stop the finance industry from extending subprime mortgage loans to subprime borrowers, but it did make it tougher to obtain. Even with bad credit or no credit, you can still get a loan for a home, an automobile, a motorcycle, a medical need, education, or another reason. It will simply take more planning and additional time.
A subprime borrower has characteristics such as a lower credit score, a higher debt load and may have a lower income.
Subprime Mortgage Loans and Credit Scores
Two situations apply to those considered subprime borrowers. They either have no credit established yet or they have poor credit.
A person who has never borrowed money before has no credit. Quite simply, borrowing money is the only way to build credit. That may not seem fair, but it is typically easy to fix. It is a common situation for high school graduates and college students. The simple fix to establish credit is to take out a small loan or a store or major credit card. Once you charge a small amount, quickly re-pay it within the time provided. Make every payment early or on time. You may only qualify for higher interest rate credit cards, but this will change once you establish credit and develop a credit score. To develop credit, you have to start small with a credit card. Once you establish credit you can move on to the larger items like a home loan.
A person with poor credit has experienced problems with repaying debt in the past or they have too many loans with not enough available credit, also known as their debt to loan ratio. Another reason is that their income seems insufficient to cover the loans they have outstanding.
Your credit score, also called a FICO score, summarizes all this information into a single three digit number. Any score 640 and above ranks as prime. Any score below 640 ranks as subprime.
That leaves a lot of room since credit scores start at 300. While 640 might sound pretty impressive, they can go all the way up to 900. The perfect score, 900, is pretty tough to obtain, but scores in the 500s to 700s are pretty commonplace.
The credit reporting agencies look at a lot when determining your score. While each credit reporting agency uses a different algorithm, weighting one criteria a little more or less than another, they all look at the same data. They consider the data points:
- when and how often you made late payments,
- cases of non-payment,
- current debt amount,
- kinds of credit accounts you have,
- length of your credit history,
- how many inquiries have been made on your credit report,
- your overall history of applying for credit,
- any bad credit behavior, such as evictions or writing bad checks.
How Does Subprime Status Affect Interest Rates?
You’ve probably heard TV commercials talking about the “prime rate” and “subprime rates.” These terms refer to the interest rate the mortgage loan offers. Getting a loan at the prime rate means you got a loan at the lowest rate possible. A subprime rate is a higher interest rate offered to those with poorer credit.
Smart Money Tip!
Since a subprime mortgage loan has a higher interest rate, the monthly payments for it cost the borrower more. This makes it even more important for people to shop around for the right loan with the best interest rate available to them. Taking out a subprime mortgage loan can require the borrower to pay out a significant portion of monthly income in repayment.
Compounding the Problem
This compounds the problem of a poor debt-to-income ratio. Typically, people who already have a poor debt-to-income ratio must take out subprime mortgage loans which have less than desirable terms. This means they are further overextending themselves and spending the majority of their income on monthly payments. This gives them little to no ability to absorb an unexpected expense or reduction or loss of income during the repayment of the subprime mortgage loans.
Costs Associated with Subprime Loans
It is not just the interest rates that cost more on subprime mortgage loans. These loans cost more to take out as a risk reduction measure by financial institutions. The fees for applying for a subprime mortgage loan and for processing it cost more. These loans also commonly include prepayment penalties which means even if you do get ahead and manage to make larger payments, you get penalized for it.
Everyone Takes on Risk
Taking out a subprime mortgage loan does not just mean risk for the bank. It means more risk for the borrower, too. The lender charges more interest and fees since its less likely it will get repaid. For the borrower, the loan proves more risky since it cost more at a time when the borrower is already stretched thin.
Subprime Mortgage Loans: Not Just for Mortgages
A small warning: the subprime crisis that peaked in 2008 will make it tougher to find a mortgage if you have less than ideal credit. It proves much easier to obtain subprime mortgage loans for automobiles, credit cards, education and personal loans. That’s because since the crisis occurred, the government strengthened consumer protection laws. Although it is harder to find them, some pre-crisis loans still exist.
How to Improve Your Loan Chances
Make it easier to whittle down your lender choices by using Loanry.com. This loan mall turns the once arduous process of applying for loans into a process more like picking up a new pair of shoes at the mall. However, keep in mind that they are not lenders, they just do their best to help you find a lender who might fit your needs.
Using Loanry: A Quick How To
Start your mortgage loan shopping at Loanry. Here’s how.
- You visit Loanry.
- You choose the loan type you need at the top of the screen.
- Complete the short form with your basic information.
- Loanry through a database of financial institutions.
- Loanry either helps you find a lender after completing a form or you can use money tools to click on ads with minimal input.
- You complete the lender’s long application on the lender’s site.
- Each lender responds to you directly.
Loanry helps you determine which lenders may be suited as the lender only responds to consumers they feel could work for their loan type. That cuts down on the research you have to do. It may even save you the application fee to banks or financial lenders for which you would not have qualified. While Loanry cannot and does not guarantee you will get a loan from these lenders, it does make looking for an appropriate lender quicker.
It also reduces the number of pings to your credit report. These hard hits, or information requests, occur each time you apply for credit. Each one lowers your credit score just a little. If you apply for many credit cards and loans, you will reduce your score, even if you did not take any out or were refused for each one.
Loanry is not a lender. It never loans money. It just makes the process of finding a loan a little easier. It also offers numerous financial educational articles like this one, so you can learn how to manage your credit better, for free.
Here’s a form you can fill out if you want us to start connecting you with lenders right away:
Try a Different Kind of Legitimate Lender
While you shop around for a mortgage loan with a still decent subprime interest rate, look into the new types of legitimate loan opportunities. While a traditional bank or credit union might refuse you, you could score a loan with a peer-to-peer lending service. Online lenders may also prove more amenable to loaning to you. Fully research any lending institution before you apply or submit your social security number. If you do use a non-traditional lender, have a financial and legal expert such as a CPA review the paperwork before you sign the application. This increases in importance if you are a first time home buyer.
Request a Meeting with the Lender
Although many financial institutions offer online applications, they still maintain local branches of their organization. If this is the case, request a loan meeting. Often, you can improve your chances of a “yes” from the bank or credit union by meeting in person with them. Your presentation and demeanor go a long way toward getting them to agree to a loan. So does the information you take with you.
Your credit score and credit report do not show everything. They only show your repayment of credit cards and loans. It does not reflect your monthly bills, rent or private loans that do not get reported to organizations like Experian, Equifax and TransUnion. It may not list your employer or salary.
Take with you to the meeting, your pay stubs proving you have regular employment and that your employer pays you a steady amount on a regular time cycle, such as weekly or monthly.
Take with you a proof of your savings accounts, Certificate of Deposits, stocks, bonds and/or retirement fund. This shows the financial institution that you can continue payments if your employer reduces your hours or terminates your employment.
Traditionally, subprime borrowers did not have these other resources. Now, however, many people have overextended their lines of credit, but retained their company IRA or still maintain a stock portfolio.
Present this documentation to the financial lender to strengthen your application. You can also take in proof of your timely payment of monthly bills to utilities, your phone company and your landlord. These items show that you pay on time and in full.
Improve Your Credit
The first step to a higher credit score is to check your credit reports. You can do this for free. Check each of the three major credit reporting agencies.
Check each report for errors or inconsistencies. Some agencies have more information than others because they include aspects the others do not in their report. For example, Experian offers individuals the ability to include their utility payments and cell phone payments in the calculation of their score. You must turn this feature on by signing up for it though.
Address any errors or inconsistencies. Report incorrect information to the credit reporting agency. Include proof of payment. If the report shows missed payments, but you actually made the payments, show this. Also, provide dated materials that refute late payments. Correcting these mistakes can result in quick increases in your credit score.
Pay your bills on time. It sounds simple, but it proves quickly effective. Just six months of paying your bills on time can raise your credit score.
One way to do this more easily is to consolidate your loans. You can turn five loans and credit cards into a single due date each month and a single payment. These also result in lower payments.
Increase Your Income
If you have been at your job for a while, request a raise. You’ll need to have been with the company for a decent length of time and produce high-quality work.
You can also obtain a part-time job. Work at it for a few months before applying for the loan. This gives you a few pay stubs to take in with you when you interview. You can either use the money to pay off existing credit lines to reduce your debt-to-loan ratio which raises your credit score or you can save it in a bank account to show that you have means to pay the loan payments for a few months if you lose either job.
You can also start freelancing as a personal assistant, blogger, Lyft or Uber driver or some other pursuit. While you will not have pay stubs, you will be able to build a savings account that lenders can consider as potential repayment monies.
How do you know if you need to bring in more income to take out a loan? Look at your current budget. If adding the mortgage loan to your existing credit and loans, will require more than 30 percent of your monthly income to repay, you need to do one of three things:
- pay off existing debts before acquiring the mortgage,
- borrow less money on the mortgage,
- get an additional job or freelance to add to your income.
Use a Cosigner on the Loan
Okay, so it hearkens back to when you were a teenager buying your first car, but you can still use a consigner. It’s not cheating if it gets you the mortgage and you know you can make all the payments, you simply need the credit worthiness boost. For those without good credit, with no credit or who have not had sufficient income for a long enough time to qualify for a prime loan, a cosigner can make all the difference.
The cosigner refers to a person who applies for the loan with you, essentially providing their awesome credit score to help get the loan. They accept absolute responsibility for loan re-payment if you cannot repay it. This transfers the majority of the risk from the lender to your cosigner.
Put Up Collateral
You can put up collateral for a loan. This provides a guarantee to the bank that you will pay back the loan. Collateral refers to a tangible asset that the bank could claim, then sell, to cover the amount of your loan. Examples include a boat, houseboat, vehicle, land or stocks and bonds.
Watch Out for Rip Off Loans
Let’s just say it straight out – don’t take a loan you can not afford. Use a loan calculator online to determine what loan amount, interest rate, and term length you can afford. Do not exceed that. It is much better to wait, improve your credit score, and obtain a reasonable loan.
Although it sounds a bit like TV, avoid going to a loan shark. They really exist and if that becomes your sole option, you need to wait to improve your credit score, so you can obtain a loan from a standard lender.
Read the Loanry blog to learn about legal interest rates, common rates and how the length of repayment times affects you.
Subprime Mortgage Loans In Depth
There are many costly mistakes that can occur when buying a home. Financial lenders use “risk-based pricing” when determining mortgage terms and rates. A subprime interest rate will be higher than the prime rate, but your credit score decides how much higher, combined with the types of delinquencies on your credit report and the down payment amount.
Subprime mortgage loans typically include a balloon payment penalty or a pre-payment penalty. Sometimes, they include both.
The term pre-payment penalty refers to a charge to the homebuyer for an early loan pay off. If you pay it before the “end of term” you reduce the amount of interest the bank receives. Whether this occurred because you wanted to refinance, you sold the home or you wanted to simply pay if off because you had the money, the bank wants its interest for extending the risk to loan you the money.
The term balloon payment refers to a lump sum payment the borrower must make to the bank after a specified time period has expired, typically about five years. If you cannot make the balloon payment, you must do one of the following:
- refinance the home,
- sell the home,
- lose the home.
Bad Credit Mortgage Alternatives
You do have other alternatives to taking out a subprime mortgage loan due to poor credit. These options also work well for those who can only manage a small down payment.
Federal Housing Administration (FHA) Loans
The FHA offers loans to people with scores below 620. You can obtain an FHA loan with a three percent down-payment.
Veterans Administration (VA) Loans
Obtaining a VA loan can help you afford a mortgage. These very low-cost loans can require no down payment.
2/28 Adjustable Rate Mortgage (ARM) Loan
This type of subprime mortgage loan offers a two-year teaser rate. After the two year period, it adjusts annually. The 2/28 ARM provides a low rate for the first two years, but thereafter goes through a sharp interest rate increase. Many buyers refinance at the two year point. The interest rate increase can cause a significantly higher monthly payment.
Bad Credit Loans
Sometimes, you have no other alternative than to take out a bad credit loan. These will have a subprime interest rate and they can go up to 25 percent which can seem like you put a house on a credit card.
How do you know when a bad credit loan is the only mortgage for which you can qualify?
Let’s say that your credit score sits on the borderline of good credit. The following things will decide whether you will need to apply for a bad credit mortgage loan:
- bankruptcy during the last 24 months,
- a foreclosure or loan charge-off during the past 24 months,
- more than one delinquency of 30 days on an existing mortgage during the past 12 months,
- one delinquency of 60 days on an existing mortgage during the past 12 months,
- your debt to income ratio is more than 50 percent,
- you were late with your rent.
Buying Your Home as a Married Couple
Here’s the deal. Just because you got married does not mean you have to do everything together. The same is true of taking out a mortgage loan. While you might think you have to put both names on the loan application and on the mortgage itself, you do not. This is great news for couples who have partners with divergent credit scores.
In fact, you can land a lower interest rate if only the borrower who has the higher credit score applies for the loan. Rather than applying as joint borrowers, save yourself money. While this means they will only consider the income of the applicant, you will know that you have two incomes and can pay the monthly costs. The loan officer must base the interest rate on the lower of the two FICO scores. The amount you save by applying with one borrower, instead of jointly, can add up to thousands of dollars annually.
This really only amounts to the tip of the iceberg of obtaining a subprime mortgage loan. You have a lot of research to do on your own, but you made a great choice getting started on Loanry.com. That’s where to shop for a mortgage. We want you to find just the right loan for you. We also want you to know what you’re getting into when you apply for a loan or sign the loan papers.
You can still obtain a mortgage with a lower credit score. If a FHA or VA loan won’t work for you, you may have to resort to a bad credit loan, also known as a subprime mortgage loan.
Carlie Lawson writes about business and finance, specializing in entertainment, cryptocurrency and FOREX coverage. She wrote weekly entertainment business and finance articles for JollyJo.tv, Keysian and Movitly for a combined seven years. A former newspaper journalist, she now owns Powell Lawson Creatives, a PR firm, and Powell Lawson Consulting, a business continuity and hazards planning consultancy. She earned BAs in Journalism and Film & Video Studies from the University of Oklahoma. She also earned her Master of Regional & City Planning at OU. Her passion lies in helping people make money while reducing risk.