Question: I am a single mother who recently took a job
with the federal government and moved to the Washington, DC
area. I own a condominium in southern Virginia and I am renting
it out with a positive cash flow. I took a short term rental
here in Washington and I'm paying $1,300 per month in rent. When
I began looking into buying a condo up here, I was informed by a
loan officer that my credit score is too low. I was laid off
twice due to company restructuring and I did indeed fall back on
some bills over the last couple of years. However, I am now back
on my feet and all bills are current and paid in full. My credit
score is 589. My supervisor says I should consider an interest
only program to keep my payments down. Should I keep trying to
get approved for a mortgage or am I wasting my time? I hate the
idea of throwing away $1,300 every month in rent.
Answer: I think it's certainly worth some extra effort
if you want to buy a condominium. The mortgage is business goes
deep and wide, meaning there's usually some kind of program for
almost everyone.
With a credit score of 589, you definitely fall into the
"sub-prime" category. This means that your credit
history places you in a statistically higher risk category for
lenders. But as I said, there's usually a mortgage available for
almost anyone. In your case, be prepared to pay a higher rate.
Let's quickly talk about credit scores for the folks who are
unfamiliar with the term. The FICO score, developed by Fair,
Isaac & Co., is a mathematical model that is supposed to
"grade" a consumer's credit. The higher the score, the
less likely the mortgage applicant is to make late mortgage
payments or default on the loan. The lower the score, the higher
the likelihood that the loan will go bad.
If you're looking for the most competitive rates, your credit
score should be above 680, but most competitive mortgage
programs will accept applicants who have scores in the 630
range. This depends entirely upon the type of mortgage program
and other aspects of the application such as down payment,
income and savings pattern.
According to Fair, Isaac & Co., 13 percent of the US
population carry a FICO score of 599 or lower. This means that
you score in the bottom 13 percent of the country.
Unfortunately, that's why you're a sub-prime mortgage candidate.
Enough said on that. Let me share some thoughts that might
help you.
First, accept the fact that you'll likely have to pay a rate
that's a bit higher than someone with perfect credit. Since
interest rates in general are at historical low levels, a
sub-prime rate probably will not be prohibitively high.
Sub-prime lenders will not just look at your credit score.
They want to see evidence that you've "turned the
corner." In other words, they will want some evidence that
you are indeed back on solid financial ground. For example, a
lender may accept an applicant with a 589 credit score but if
your credit report indicates that you have been late on your
rent more than two times in the last 12 months, they may not
grant the loan. They would rather see your credit report show 10
late payments that occurred more than a year ago than two late
payments within the year.
Most sub-prime lenders offer primarily adjustable rate
mortgages (ARMs). But this isn't so bad because the rates will
be considerably lower than fixed rates. An interest only option,
as your supervisor points out, is a possible alternative because
it allows for low mortgage payments. However, an interest only
mortgage allows you to possibly borrow more money -- something
that may not be advisable for folks trying to get out of a bad
credit situation. Make sure you can truly afford the amount of
money that you're borrowing.
The last thing to mention is down payment. Sub-prime lenders
do indeed offer 100 percent mortgage programs for scores as low
as 589. But they will want to see that you've "turned the
corner," so make sure you haven't made multiple late
payments on your rent over the last six months.
Depending upon your down payment and the specifics of your
application, expect to pay an interest rate between seven and
nine percent. This rate may be fixed for two years and adjust
annually thereafter. Also, be prepared to pay at least one
point. (One point is equal to one percent of the loan amount
paid in cash at settlement.)
In my view, paying two or three percent over the most
competitive programs is a small price to pay if your alternative
is renting. To put things into perspective, the lowest
adjustable rates available in the early 1980s may have dipped
below ten or eleven percent -- so eight or nine percent isn't so
bad.
Published: October 2, 2003
