If you think having flawed finances will stop you from buying a home, you need to hear what these mortgage experts have to say. For example, you may think that the three-digit number known as your credit score could spell doom for your plans to purchase a home. But don't rip up that mortgage application just yet.
"Believe it or not, it is not as difficult as one may think to purchase a home with less than perfect credit," says Eric Small, a consultant for several mortgage banks in Orange County California.
Read on to learn about some common financial problems - and the savvy solutions recommended by mortgage experts.
Problem #1 - High Debt-To-Income Ratio (DTI)
If you've looked into getting a mortgage, you may have heard the term "DTI." So, what exactly is it and how can it impact your ability to get a loan?
DTI is your debt-to-income ratio - a percentage calculated by dividing your monthly payment on long term debt by your gross monthly income, explains Alyssa Schwabe, content and social media coordinator at GSF Mortgage Corp. "The higher their DTI, the harder it can be to get a loan," she explains.
"Lenders and investors like to make sure a borrower is not going to fall behind on their payments," says Schwabe. So what constitutes a high debt-to-income ratio? You can look to the recent Dodd-Frank Act to get a clear idea.
"The new lending regulations are going to limit borrowers to a 43 percent debt-to-income ratio," says Small. When banks sit down to calculate what they think you can afford, they include all your current bills along with what the new mortgage will cost you every month.
Homebuyer Solution: "Consider cutting back on items that will reduce your perceived ability to pay monthly debt," suggests Gloria Shulman, founder of Centek Capital Group and a Southern California mortgage broker with 30 years of experience."A good place to start is your choice of vehicle. Instead of financing that fancy new car that is a depreciating asset, consider buying something used with either lower monthly payments or cash."
Or if you're in the midst of paying off your car, Anthony Pili, vice president at Greater Hudson Bank in Bardonia, NY, suggests another strategy for lowering your DTI. "If you have a car loan with 12 months remaining, refinance it for an additional 36 months to lower the payment. Of course, you can still pay it off in 12 months but your ratio will be improved so that you can obtain your mortgage."
Problem #2 - Low Credit Score
"Your credit score is the single most important snapshot of your credit health and represents all the information on your credit report - including your credit accounts and payment history," says Ken Lin, chief consumer advocate for Credit Karma, a personal finance site.
Lenders see a low credit score and worry that you're not a reliable borrower - so this could negatively impact your odds of being approved for a loan. And if you still qualify for a loan, a low credit score could still cost you.
"Credit scores are directly tied to interest rates," says Amy Tierce, regional vice president of Fairway Independent Mortgage Corporation in Newton, MA. "The lower the credit score the higher the risk associated with the loan, therefore the higher the interest rate."
Homebuyer Solution: "Get copies of your credit report; write down the most important aspects of your financial situation and your homeownership goals," says Dana Anghel, loan officer in Sandy, UT. "Then discuss your situation with a mortgage professional (or two) and ask them which areas need improvement. Work with someone that feels both honest and helpful."
In addition to assessing your credit, you should make all payments on time, clear up active collections against you (with the help of your mortgage lender), and keep your credit balances below your 50 percent max balance, says mortgage banker, Michael Metz. "These steps will help show the credit agencies that you're low risk, and this will help improve your scores," Metz says.
Problem #3 - Low Down Payment
For many aspiring homebuyers, buying a home seems out of their reach. A major factor deterring them is the traditional 20 percent down payment. While that's been the standard for quite some time, saving that much cash today can be a real challenge.
But thankfully, 20 percent is not set in stone as the only percentage that will get you a mortgage. Lenders are lowering minimum requirements, including the down payment, to attract borrowers, notes a November 2013 report by Lending Tree. And with home values improving and homebuyers less likely to default on their loans, lenders aren't as worried about lending with less cash down from qualified borrowers.
In fact, the average down payment on a house has dropped to 15.73 percent, according to Lending Tree. But if that figure still seems like a difficult feat, there are other solutions to help you purchase a home with an even lower down payment.
Homebuyer Solution: Depending on your situation, you might be able to find a way to buy a home with a low down payment. So check out these different strategies to see if any of them could help you get closer to your homeownership dreams.
• Conventional Loan: If you have a good credit score of 700 or above, you can get a conventional loan with a down payment as low as 3 percent, says Anghel. With a minimum of a 620 credit score, you can get one with a down payment as low as 5 percent.
• FHA Loan: The Federal Housing Administration (FHA) loan option might be the right choice if you have a low credit score, says Small. With an FHA loan, your credit score only needs to be 500 to qualify for a 10 percent down payment loan and above 580 to qualify for the 3.5 percent down payment. Keep in mind, however, that only a few banks offer this type of loan to borrowers with credit scores this low, he explains.
• VA Loan: The Veterans Affairs (VA) loan has similar criteria as the FHA loan, says Small. But it's geared toward past or present military personnel. The aim of the VA loan program is to provide home financing to eligible veterans where private financing isn't generally available, typically in rural areas and small cities. Veterans may also be able to purchase a home with no down payment through a VA loan.
• State-Sponsored Down Payment Assistance: Another option for borrowers are down payment assistance programs sponsored by certain states, municipalities, and non-profit organizations, says Cook. For example, in Ohio, there is a state loan program that may offer assistance for a down payment as little as 3.5 percent, explains Aaron Ferkinhoff, Loan Officer at Academy Mortgage in Cincinnati, OH. Similarly, certain cities and towns also provide down-payment assistance for borrowers who plan to live in their city and earn below a certain income level. But these programs may be limited to first-time homebuyers, Cook notes.
These loan programs are a just a few of the options available to borrowers struggling to come up with a down payment. Make sure to conduct thorough research to ensure you're picking the right option for your needs.
General Tip - Work with a direct lender or mortgage banker.
Getting a mortgage is an expensive proposition - and without guidance from a qualified professional you could pay substantially more than necessary. If you've got financial issues, going to a regular bank might not be the right solution for you. Instead, you should work with a direct lender or mortgage banker, says Phil Georgiades, Chief Loan Steward for VA Home Loan Centers.
Why? Well, if you work with them directly, mortgage bankers and direct lenders might be able to make exceptions to some of their guidelines. For example, they might allow a borrower to get a loan with a higher DTI - perhaps up to 50 percent rather than 43 percent, according to Anghel.
Direct lenders or mortgage brokers could also help someone with flawed finances get a loan that a “regular bank” might not be willing to give, she explains. Banks may only offer a limited range of loan products, which may not include special loan programs or the flexible underwriting that you may need.
So the right mortgage professional can help steer you through the process, guide you to the right products, and help ensure you don't get in over your head.
"This will probably be the biggest transaction of your life," says Ken Maes, NW divisional vice president of Skyline Home Loans. "Look for a local company that is approved by Fannie Mae, Freddie Mac, and Ginnie Mae - all of the three main government service agencies," he advises. "Next, pick a loan officer from that firm who will sit down to build you a game plan to deal with any credit, income, or down payment issues."