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Convince your bank that you’re mortgage-worthy

People with low FICO scores do get home mortgages, even today. Here’s how they do it.

By Marilyn Lewis

If your credit score is in the tank, you might think you’re out of luck when it comes to getting a mortgage. But that’s not necessarily true. Despite the tight-credit era ushered in by the housing crash, people with FICO scores in the 600s and below do get mortgages.

If your credit score is below 680, there are three important things to know before you apply:

1. You’ll need to be prepared to pay more for a mortgage than someone with a stronger credit score. How much more? We’ll get to that in a minute.

2. When you have “impaired” credit, your ability to get a mortgage hinges to a large degree on the answer to this question: Why is your credit score low?

3. It’s hard to get these loans. You’ll have the best luck with a mortgage broker, loan officer or lending company with expertise in helping low-score borrowers.

You’ll pay more
The best interest rates go to mortgage borrowers with scores of 720 and above. However, many people are surprised to learn that home loans do still exist for people with flawed credit.

Slide show:  The best home loan for your credit score

The catch? It will cost you more. Often, a lot more. You can experiment with the calculator atMyFico to see the differences. Here’s an example of the added interest costs on a $200,000 mortgage:

Low credit scores pay more
FICO score Rate Payment*
760 to 850  3.986% $958
700 to 759  4.208% $984
680 to 699  4.385% $1,005
660 to 679  4.599% $1,031
640 to 659  5.029% $1,084
620 to 639  5.575% $1,152
*Note: Based on a $200,000, 30-year fixed-rate mortgage
Source: MyFico

Before committing to an extra-high-priced mortgage, ask yourself: Is purchasing hundreds of thousands of dollars’ worth of real estate the best for your finances right now? You may do better by paying debts and re-establishing solid a financial footing. For trustworthy help, call the National Foundation for Credit Counseling at 800-388-2227 and check out this guidance from the Consumer Financial Protection Bureau.

But not all low-score borrowers are in hock. Doctors, for example, are “notorious” for having bad credit, even with solid incomes and lots of cash in the bank, says Eric Mitchell, vice president at Priority Financial Network, a mortgage bank based in Calabasas, Calif. “It’s common to see a doctor making $500,000 a year living below their means with a 580 credit score because they’re so busy doing what they do [that] they forget to pay their bills on time,” he says.

The ‘demilitarized zone’
It’s not just more costly to get a loan when your score is low. It’s also more difficult. The average credit score for a Federal Housing Administration purchase is 693. This year, just 42% of FHA home loans (PDF) have gone to borrowers with scores between 620 and 680.

The lower your score, the more difficulty you will have. Of all mortgages made between August and October 2012, only 4% went to borrowers with scores under 620, according to FICO, the credit scoring company. In 2006, when lending was looser, about 18% of borrowers had scores under 620.

Mitchell calls scores between 580 and 620 the “demilitarized zone.” “There are options, but man, it’s tough” to find them, he says.

His company, Priority Financial Network, offers low-credit loans because it strives to be a one-stop shop to which real-estate agents can send clients. Some of those clients have dinged credit, so although low-credit loans don’t mean much profit, Priority includes them among its offerings. Although 80% of lenders lend at a minimum 620 FICO score, Mitchell says, “We will go below 580, on a case-by-case basis.”

Subprime or ‘nonprime’ is creeping back
Despite the obstacles, even borrowers with scores below 580 sometimes can get mortgages. Subprime loans – for borrowers with low scores – got a bad name because of dangerous features often attached to them at the end of the housing boom: stated-income loans, with no need to prove you qualify; option ARMs that led borrowers deeper into debt; and low, low teaser rates that exploded eventually into higher rates with hopelessly exorbitant payments. Those products disappeared after the mortgage crash, and some will be illegal starting next year.

Recently, though, “non-conforming” mortgages, with rates higher than those offered by banks, are appearing again. These are “old style” mortgages where borrowers make big down payments, typically 25% to 60%, wrote Inside Mortgage Finance, an industry publication.

Citadel Servicing Corp. in Irvine, Calif., is one of very few lenders lending mortgage money to borrowers with FICO scores as low as 500. It began in April making fixed-rate and adjustable mortgages of $50,000 to $750,000 using money raised from private investors. These mortgages don’t qualify for government backing, which makes them considerably more expensive.

Citadel CEO Dan Perl calls himself a “nonprime” lender. The term “subprime” denigrates borrowers, he says. “We’re talking human beings who have had some bumps in the road.”

Tell your story
A low-score mortgage application is judged in large part not by the score but by the strength of the borrower’s story about why that FICO score is low.

“When you’re dealing with people with low credit scores, really, it’s a matter of, ‘What’s the story?'” Mitchell says. “If you simply have a longstanding habit of forgetting to pay your bills on time or failing to pay them, you probably won’t get a loan.”

But if your score is low because you were hit by what lenders call “complicating factors” or a “life event” beyond your control, your chances improve.

“Maybe there was an illness. Someone became disabled. Deaths in the family” – all of these are reasons that could lead a lender to overlook a low score, Mitchell says. Job loss may count, depending on the circumstances.

“Divorce doesn’t count,” he says, “although, as a divorcé, sometimes I want to argue that point.”

Lenders’ guidelines are explicit, but, ultimately, whether your file is approve is up to the underwriter, who decides if it fits the lender’s criteria. To make your case effectively, find a way to frame your story that resonates with the underwriter.

“A tremendous amount is subjective, is up to the discretion of the underwriter,” Mitchell says. “There’s a saying in the Midwest, ‘If you can make the underwriter cry when they’re reading the file, the loan’s approved.'”

Finding your loan
To find a mortgage, you’ll need to find a broker, loan officer or mortgage banker with experience, skill and the motivation to help, since your application may take them “three times the work for the same amount of compensation,” Mitchell says.

Software is used to screen applications based on standard sets of qualifications. Exceptions are sometimes allowed, but those cases must be vetted by hand. Ask around for a mortgage seller able to “manually underwrite” your application. If a loan officer appears unfamiliar with that term, keep searching, Mitchell advises. It may mean finding someone who’s been in the field at least 20 years, as manual underwriting was more common then.

Cara Hawkins, who oversees mortgage loans at Ameripro Funding, a Texas-based lender, says she does manual underwriting for clients, particularly those applying for FHA loans. She looks for chances to boost an application by resolving easily fixed problems on borrowers’ credit reports.

“If I see a borrower come through with a score in the high 500s, I will go through the credit with a fine-tooth comb and analyze and see if there is anything that can be remedied in 30 to 90 days,” she says.

She helped one borrower raise her score 65 points by making payments on credit cards, which raised her available credit and made her more credit-worthy. “She had to pay only a couple hundred dollars on each card, and it took a week to rescore,” Hawkins says.

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