Subprime mortgage loan: what to do if your credit is not perfect
“Specialty financing” or “loans for someone with less than perfect credit” are polite terms used to market “subprime” or “non-prime loans”. Sometimes they are effectively the only way to homeownership for those who have frequent late payments, bankruptcies, liens, judgments or other mishaps tarnishing their credit history. People with below-standard credit histories will end up with above-market interest rates and unfavorable terms, but get a chance to re-establish their credit.
According to the Mortgage Bankers Association, in 2003 the lenders issued over $276 billion in subprime mortgage loans, roughly 14% of all mortgages, compared to 11% in 2001. The subprime mortgage market witnessed a boom since the 1990s. The idea of a non-prime loan goes back to the late 1980s, when the usury laws were relaxed, which allowed lenders to raise interest rates in order to compensate themselves for higher risk. In 1994 the market was given a new impulse with the securitization of the loans and assignment of credit scores to borrowers in the form of letter grades with A representing the highest grade.
Now any customer can have his or her score evaluated by one or more of the three major credit reporting agencies: Experian, Trans Union, and Equifax. A copy of your credit file costs about $8 in most cases. It makes sense to check whether the information presented in your credit report is correct and does not contain any erroneous facts that dampen your credit history so that you do not fall into the bad credit category due to someone’s mistake.
Lenders will want to consider many factors such as debt to income levels, employment history, type of property, and lack of assets. If your mortgage payment exceeds 40% of your gross monthly income or you are employed less than two years, they may place you into the non-prime category.
If you get a low rating anyway, start shopping around for a subprime loan with favorable terms. Some imperfect credit lenders have earned a bad reputation for trapping unsuspecting customers in excessively costly mortgages with abusive terms. It is estimated that predatory lending costs deceived borrowers $9.1billion annually. That is why make sure you understand all the terms and conditions involved. It is usual for subprime lenders to offer unfavorable terms and pre-payment penalties, it is extremely difficult to obtain a long-term fixed loan in this sector, but odds are you can get a better deal by just asking a few more lenders. Do not be afraid to damage your credit history by too many inquiries from potential lenders: credit rating agencies lump together all the requests on your credit report that came within two weeks and count them as one inquiry. So do not be ashamed to confront brokers or loan officers with explanations of your late payments. If you were 30 days behind, they probably will not think of it as a major delinquency, and it helps if you can account for your imperfect record with circumstances like illness, job layoff, marital problems and similar external disruptions of your financial stability.
Undoubtedly, the biggest disadvantage of loans for less-than-perfect credit borrowers is the higher rate that can be 5 or 6% higher than the usual interest rate. Simple calculations show that the family paying 4% more on a $120,000 mortgage will pay an extra $300 a month that adds up to the extra payments of about $100,000 over the life of the loan if it is for 30 years. However, most wise borrowers start looking around for a lower rate to refinance their house in a year or 18 months, after they clean up their credit record through disciplined payments and build equity in the house. Some lenders now offer their customers with flawed credit a credit card secured by the equity on the home. The sensible use of the card helps homeowners repair their credit history. Another option is to apply for a loan in the form of checks that can be cashed to activate the credit line.
Also, subprime loans make financial sense since they allow you to get into the house at today’s price and in most cases deduce the higher interest from your taxable income. If you compare mortgage payments to the strain on put on your budget by the rent payments, you may want to consider a subprime loan despite the high costs associated with it. Monthly payments can also be reduced in debt consolidation.
It is up to the consumer to decide whether it is wise to get a mortgage now even at a higher rate, or wait for a change in one’s credit situation, but one fact remains true: the evolution of the subprime credit market has brought the dream of home owning closer to many households.