Your Guide to Credit and Personal Finance

Low-credit score loans
You can still get a good rate on your mortgage with less-than-perfect credit with an FHA loan.

A mortgage is a major expense. But it can be even more costly when your credit score is less than perfect as you may end up being charged a higher interest rate for a subprime mortgage.

How do you avoid having to pay a higher rate? One way is to pay down your debt, and establish a good track record of paying your bills on time. But it can take up to a year to show results.

There is another way, however, and that’s to consider an FHA (Federal Housing Administration) mortgage. These loans use different criteria than other mortgages, and that may allow lenders to offer you terms only slightly higher than market rates — in some cases, as little as .125 percent higher.

FHA mortgages
It’s important to understand what an FHA mortgage is. Contrary to some people’s belief, the Federal Housing Administration is not a lender. It is a federal government agency that guarantees loans by private lenders, making mortgages available to people who may have a difficult time qualifying , often because of a lack of credit history. This includes recent college graduates, newlyweds, as well as people who have had credit problems including bankruptcies and foreclosures. Since an FHA mortgage is government-insured, lenders granting these mortgages assume less risk than they do with other low credit score loans and therefore can extend credit at a more reasonable interest rate.

How to qualify
The qualification criteria for an FHA mortgage are different than they are for a conventional loan. While your credit score is usually the most important factor lenders consider when approving you for a conventional loan, with an FHA loan it’s not the central consideration. Rather, the FHA looks at your overall credit history, and is often more flexible in considering mitigating factors.

That doesn’t mean you don’t have to get your credit under control. The FHA requires a one-year period of acceptable credit, during which you have made all your payments promptly. It may review your rental or mortgage payment history during that time, any new credit or credit inquiries, and whether you have paid off any judgments against you. And it considers your debt-to-income ratio to ensure you’ll be able to repay the loan.

Advantages

• The FHA may not hold an unpaid collection against you if there is a valid reason for not paying it.
• You can qualify three years after a foreclosure, as opposed to the usual four years with a conventional loan.
• Your down payment can be as little as 3 percent of the loan amount.
• The down payment can be a gift from a family member, government agency or non-profit organization.
• Your housing expenses (PITI) and other debt payments can total 41 percent of your income, compared with the usual 33-36 percent for a conventional loan.

Disadvantages

• There is a limit to the amount you can borrow that varies depending upon your area.
• You may have to take out a second loan if, due to regional limitations on the amount your can borrow, an FHA loan does not provide you with sufficient financing. (On a $100,000 mortgage, the 1.5 percent upfront mortgage insurance payment would be $1,500 which, wrapped into a fixed, 30-year mortgage at 8 percent, would come to an additional $11.01 per month. The 0.5 percent annual premium would be $500 per year or $41.67 per month.)

While an FHA mortgage may be the answer for you, not all FHA mortgages are the same. So look carefully at the rate and other features, and compare FHA mortgages from different lenders before you sign.

Buying a home with a low down payment
Looking for a mortgage that doesn’t require a 20 percent down payment? Here are some options.

You’ve found a home you’d love to own, and you’re ready to buy. But you don’t have a 20 percent down payment. Don’t worry; there are several low-down-payment alternatives.

Private mortgage insurance
It’s possible to get a mortgage with a down payment of as little as 3 percent by taking out private mortgage insurance (PMI). This insurance protects the lender in case you default on your mortgage payments by ensuring that the outstanding balance will be paid off.

The cost of PMI varies but, in general, it’s about one-half of one percent of the mortgage amount per year, or $500 for a $100,000 loan. The good news is that once you’ve paid down your mortgage to the point where you achieve 20 percent equity in your home, most lenders will allow you to cancel the insurance. You may also be able to drop it if an updated appraisal indicates your equity has increased sufficiently due to an increase in the value of your home.

PMI can sometimes be financed through your mortgage loan (often called a self-insured mortgage). You will likely have to pay a higher interest rate, but the payments are usually tax-deductible as mortgage interest.

FHA loans
A second option is to apply for an FHA mortgage. These loans, designed for those with less-than-perfect credit, are insured by the Federal Housing Administration and also allow a down payment as low as 3 percent.

The down payment can be a gift from a family member, government agency or non-profit organization. However, there is a limit to the amount you can borrow, which varies depending on your location. You will also be required to take out FHA mortgage insurance. In most cases, this insurance costs 1.5 percent of the loan amount on closing, plus 0.5 percent per year — the amount can be rolled into your mortgage.

On a $100,000 mortgage, the 1.5 percent upfront FHA mortgage insurance payment would be $1,500 which, wrapped into a fixed, 30-year mortgage at 8 percent, would come to an additional $11.01 per month. The 0.5 percent annual premium would be $500 per year or $41.67 per month.

Government-insured loans are also available for those with military service under the Veterans Administration (VA) loans program, and for rural residents under the Rural Development Housing and Community Facilities program.

Piggyback loans
Also called a second trust loan or second mortgage, a piggyback loan is a second loan that closes at the same time as your first mortgage. The idea is to combine this loan with your down payment in order to reach the 20 percent needed for a conventional mortgage.

The most common piggyback loan is an 80/10/10: your mortgage equals 80 percent of the purchase price, and your second trust loan and down payment each equal 10 percent. There are also 80/15/5 loans, which require you to put down only 5 percent.

With this arrangement, you’ll have two loans to pay each month. And the interest rate on the second trust loan will likely be higher than that of your first mortgage. In addition, paying the closing costs on another loan will add to your upfront expenses. But your total payments may be less than they would be if you were paying for PMI. Plus, the interest on a piggyback loan may be tax-deductible, though you should consult a tax advisor about your situation.

What to look for on your credit report
There is a wealth of information listed on your credit report. Here’s how to focus in on key sections and make sense of it all.

You’ve pulled a copy of your credit report and are now looking at a tangle of information. You see your last three addresses, a long list of businesses that have checked your report and dozens of credit accounts. But what does it all mean? Which information should you look at first? Here’s a quick rundown of your credit report and the key information on it.

Why should I care about my credit report anyway?
A credit report is a factual record of your payment history and other credit-related items that lenders use to help determine whether to grant you credit. The information on your report is compiled by the credit bureaus, which regularly receive data on whether you make payments on time and how much you owe. Since creditors are constantly reporting new information to the bureaus, your credit report is always changing.

What should I be looking for?
In a word, inaccuracies. Mistakes are not entirely uncommon on credit reports. Sometimes they’re caused by simple human error, other times they occur when credit files of people with similar names are inadvertently mixed. Increasingly, unfamiliar or inaccurate information can also be an indicator of identity fraud - when someone uses your name and accounts without your knowledge. Look closely at the following areas to catch mistakes or fraud:

• Personal information. Are the names and addresses listed on your report accurate? Often, an incorrect address or unfamiliar suffix, such as Jr. or Sr., can be an indication that your file may have been mixed with that of another person. Additionally, a recent address change may indicate that someone is fraudulently opening accounts in your name, but routing the bills to their address.
• Public records. If any bankruptcies, judgments or liens are listed in this section, make sure they are accurate and complete. Remember, some bankruptcies can stay on your report for up to 10 years while others cycle off after seven years.
• Accounts. You will notice basic information such as your credit limit, current balance and date the account was opened. Also check out the detailed payment information by month for incorrect late payments or charge-offs. Remember to check for unfamiliar accounts or activity on accounts that you thought were closed. Someone besides you could be using the account.
• Inquiries. This section shows you who has received information from your credit report and who was given your name during the recent past, as allowed by law. Often, credit grantors will “pre-screen” your credit file in order to offer you special rates. Additionally, inquiries are recorded when you apply for new credit or authorize an employer or insurance company to check your credit history.

What next?
If everything looks accurate, then you can breathe easy. Just remember to regularly monitor your credit to make sure everything stays accurate.

If you find a mistake, then you have the right to dispute the information free of charge. You should contact the credit bureau that provided the information and dispute the inaccurate information. You can also contact the creditor and ask that new, accurate information be provided to the credit bureau.

Finally, if you suspect fraud, contact the credit bureaus immediately and place a fraud alert on your report. Then, contact your credit card companies and bank to protect your accounts.

This information is provided in partnership with ConsumerInfo.com, an Experian company.