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Bad Credit? No Problem. Here's How to Get a Home Loan

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You’ve found
the house

. You have the savings for a down payment and the cash flow in
your budget to afford the payments. Everything is great, except
for one thing: Your credit score is bad. Is this a death knell
for your home purchase?

Maybe. But then again, maybe not. Here are the best strategies
and tactics you can follow to overcome that credit score and buy
the house in spite of it.

What is a bad credit score?

Generally speaking, credit scores break down as follows:

760+

Excellent
710-760

Good
650-709

Average
620-649

Below Average
Below 620

Poor

There are tons of different reasons a credit score could fall;
however, moving into that below average or poor range takes a
pretty serious event like several missed payments, bankruptcies,
foreclosures, or collection accounts. But don’t worry… life
happens to even the best people, and a missed payment in the past
is not the end of your home buying journey.

A bad credit score simply indicates to a bank that you’ve had
trouble repaying debts in the past. To overcome that history, you
must take extra steps to prove to the bank that history won’t
repeat itself. To do this, you must think like a bank.

How to think like a bank

Banks care first and foremost about getting repaid. That means
you must prove to the bank that the loan will be repaid.
Remember, as we work through these concepts, you probably won’t
have every “i” dotted and “t” crossed. That’s OK. At the end, we
will bring it all together with a solution for the worst-case
scenario.

Question 1

:
How are you going to repay the loan?

Typically, the answer to this question is through your monthly
cash flow. This is the income from your job after you subtract
your living expenses like food, water, electricity, debt, etc.
Banks use a ratio called the debt-to-income ratio to determine if
your monthly cash flow is sufficient to afford the debt. The
ratio is calculated by dividing your total monthly debt payments
into your total monthly income (before taxes).


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.

For borrowers with good credit, a 40%-50% debt-to-income ratio
is typically enough to qualify for the loan. For those with
credit problems, this ratio needs to be much less.

Question 2

:
If that doesn’t work out, what is the backup plan?



What happens if you lose your job? That could be the reason your
credit score isn’t the best in the first place. The reality is
that this can happen and, when it does, both bank and borrower
feel the financial pressure. That’s why banks always look for a
backup plan.

Do you have any savings or cash hidden under the mattress?
Banks will want to see enough savings to cover your living
expenses and debt payments for at least six months. The more
savings, the better.

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It gives the bank comfort that, if something goes wrong, you,
your family, and the bank will all be financially stable until
you can find another income source.

Question 3: What happens if your backup plan
fails?

It may seem like overkill, but banks want a backup plan for the
backup plan. When all else fails, the bank wants to make sure
that if the house must be sold, the loan will be repaid.
Unfortunately, this often means foreclosure.

To you, that means a bigger down payment. By putting in more
of your money up front, it creates breathing room for the loan if
it must be sold quickly. If a conventional mortgage requires a
20% down payment, try to put down 30%, 40%, or more.

You may be thinking, “Why should my family put in more money
now just so the bank won’t lose money later?” Well, if you don’t
do this, you most likely won’t get the loan. And if you accept
the loan, you’re giving your word that you’ll repay the debt. As
long as you pay the monthly payments as you’ve agreed to do, you
have nothing to worry about.

Putting down a bigger down payment will benefit you by
lowering the monthly payment, as well, making it less likely that
you’ll ever be in the worst-case scenario in the first place.
Even further, it gives you more leeway to sell the house yourself
prior to foreclosure, saving your credit score from further
damage in the future.

Again, the idea with all of these considerations is that,
because your credit score is low, you need to prove beyond a
shadow of a doubt that you can
and will

repay the loan.

The worst-case scenario

What if you’ve worked hard, saved up, dotted your “i’s” and
crossed your “t’s,” but the bank still won’t approve your loan?
You have the cash flow, the savings, and the down payment, but
you still get declined for a conventional mortgage?

At this point, it’s time to look at subprime options. Subprime
is a kind of dirty word in the post-financial crisis world; but
that doesn’t mean it’s not a viable solution for many
families.

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With a subprime loan, the specialized banks and lenders
mitigate the perceived risks of a loan by charging a
substantially higher interest rate. They lower their lending
standards so that you can get the money you need. The higher
interest rate is, in essence, the bank charging more for lowering
those standards.

The subprime loan will be much more expensive, but at least
you’re able to get the financing you need to buy the home. Over
time, as your credit score improves, you should be able to
refinance that subprime loan into a conventional loan with a
better rate.

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The article
Bad Credit? No Problem. Here’s How to Get a Home
Loan

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