Game plan for preparing to buy a home when you’re credit score is low

I don’t blame anyone for wanting to own a home.  Sometimes when I meet with clients and review their current scenario, a game plan needs to be created so they can work on getting themselves into a better position to buy a home.  The last thing anyone wants is to cram themselves into a mortgage they cannot afford or to commit to a long term payment when they don’t have a great track record of making payments on time. Some times a plan may take 6 months or a year or longer before someone is ready to buy a home.

I have someone with low credit scores who wants to buy a home.   She knows she will probably be a candidate for FHA financing because she has little down payment and her credit.  Although FHA is not as persnickety about credits scores as conventional financing, they scrutinize credit history: especially the last 12 months.

This person has a few late payments this year, the last one being as recent as August.  FHA financing is most likely out of the question for her until August next year assuming she does not make any other late payments between now and then. She can work on her credit for the next 10-12 months (until she has 12 months since her last late payment).   She doesn’t have any collections but she does have a few small accounts that are “maxed out”. 

  • Credit card “A” with a balance of $477 and a limit of $500.
  • Credit card “B” with a balance of $323 and a limit of $300.
  • Credit card “C” with a balance of $215 and a limit of $300.
  1. The first thing she should do is focus on getting card “B” under the limit of $300.  She’s getting whammo’d with her credit scores for being extended beyond what her credit limit is with this account (in addition to being maxed out).   She should at least pay it down enough to make sure that her interest fees won’t keep popping her over her limit.
  2. Next she should select one of her two smallest cards to pay down to at least just below 50% of her card limit.   Card “C” would only take about $65 to bring her debt down to 50% of the line limit (300 x 50% = $150).
  3. Then pay down the next card to at least 50% of the limit.  “Card B” will take $150 (assuming she’s paid the extra $23 that has pushed her over the limit) to be at 50% of the credit line limit.
  4. Credit card “A” will take a little extra cash at $227. (500 limit x 50% = $250.  477 – 250 = 227).

She needs to keep her credit below 50% of the credit line at the very minimum.  I know I said FHA is not as picky as conventional.  However, you do want your credit scores above 600 in order to receive better pricing (620 and higher is even better).

Not only will this help her with qualifying for FHA financing, she’s probably also paying higher insurance rates due to her current credit scores. 

She has a decent income and no savings.   She needs to use this time of working on her credit to also build up her reserves.  Not only for what the lender will require (3.5% minimum down payment for FHA as of January 1, 2009); but for her sake should her income change or issues arise, she should have a minimum of 6 months worth of living expenses saved (FHA does not require this, I’m suggesting it).

She has been considering homes priced around $275,000.  FHA’s minimum required investment for this home next year will be $9,625.  The seller can pay the remaining closing costs and prepaids as long as she has met the above requirement (which can be a gift or loan from family members)–this would need to be negotiated in the purchase and sale agreement. 

The proposed mortgage payment would be around $2,000 (including taxes, home owners insurance and mortgage insurance).  This is $700 more per month than what she is currently paying for rent.  Once she has corrected her credit, she should practice making a $2000 mortgage payment by paying the difference ($700) into a savings account that she leaves untouched for her down payment and to hopefully create a savings cushion.  $12,000 in savings would be ideal (6 months of mortgage payment) but not required.   If she has no savings, it will take her just over a year to pay $700 per month to come up with the down payment (9625 divided by 700 = 13.75).  Another 17 months to have a savings cushion of $12,000. 

I know this isn’t instant gratification.  It is developing responsible financial habits.  There are expenses to owning a home beyond renting.  One of my last homes required a new roof just months after moving in to the tune of $15,000.  Savings has always been important and it’s even more true in our current economy.

She’s all ready moving in the right direction by contacting a Mortgage Professional who is interested in her long term financial well-being and is willing to help her create a game plan.

Check out my related articleGetting on Track to Buy Your First Home

Should You Refi?

EDITORS NOTE: This post was written back in 2008 and mortgage rates have obviously changed 🙂  If you would like a mortgage rate quote based on current rates for your home located in Washington state, click here.

Last week I did a quick alert on the 30 year fixed hitting high 4’s-low 5s and I received an excellent comment from Sandy:

“…With all the costs and everything of refinancing, how much lower do rates need to be than what you currently have, before it makes sense to think about refinancing? I am just curious, as we have a 30yr fixed loan that is in the low 5s.”

You would think this is a simple question with a simple answer.  There’s much more to it.  Here are some things to consider if you considering refinancing your mortgage:

How long do you plan on staying in your home?   There are cost to the mortgage even if you’re getting a “no cost mortgage” where the hard costs are actually financed into the interest rate.   If you cannot break even on the cost before you plan on selling or refinancing again (low 4’s to high 5’s would be unlikely), then refinancing for the purpose of reducing your rate may not make sense.

Do you have an Adjustable Rate Mortgage?  If you’re going to retain your property longer than the remaining fixed term on the ARM (adjustable rate mortgage), you may want to consider refinancing into a fixed mortgage.

Do you have private mortgage insurance or a second mortgage?   Sometimes if someone has pmi or a piggy back second mortgage, refinancing may make sense if the can restructure the existing mortgages into one and if the blended rate of their existing mortgages are higher than what the new mortgage would provide.

Do you have a Jumbo mortgage?  Depending on what your mortgage balance is and your current rate, it may make sense to restructure your mortgage into a conforming mortgage.  This can be done by paying down the mortgage at closing or using a second mortgage, such as a HELOC or fixed second.

Would you like access to your home equity?   Refinancing can provide cash for home improvements, college tuition, debt consolidation, or what ever else you wish to do with your equity.   Most cash out refinances are priced higher than a rate term refinance.

Are you getting a divorce or separation?  If you have a mortgage with another person and the relationship is dissolving; you will need to refinance in order to remove the one who’s not staying in the home from the mortgage.   Divorce decrees and Quit Claim Deeds do not remove someone’s liability from the mortgage.  Plus, it’s a huge risk for the person who is no longer staying in the home.   Refinancing to remove an ex-spouse from the mortgage and to cash out their equity is not priced as a “cash out” refinance–it’s treated as a rate term refi.

Are you concerned about your home value declining?  Refinances are priced based on loan to value and there are underwriting guidelines that limit how high a loan to value may be.  In “declining markets” lenders have additional restrictions on loan to value lending limits.

Here are some quick “Do’s and Don’ts” for your refinance:

  • Do get a good faith estimate from your Mortgage Professional.  If you have not heard from your Mortgage Professional since you closed your loan or over the past few months, you might need a new one (they could be out of the business).
  • Do not rely on a simple “rate quote” without knowing the costs involved.
  • Do complete a loan application and provide the information your Mortgage Professional needs to lock in your interest rate.
  • Do not try to “play the market” and get the lowest rate…it’s far too volatile in this climate.   If the rate makes sense, lock it!

Must reads:

Picking your next mortgage by rate shopping?   You might as well be playing liars poker.

I’m happy to adopt your ARM.  No refi required.


Please Don’t Neglect Your Unhealthy Mortgage

ErToday I received a phone call from a CPA who was trying to help her clients who have a "toxic mortgage".   She was hoping I would be able to save them…there was a time that I probably could perform a "rescue".   In fact it was just a few months ago before the current mortgage melt down.   Believe it or not, when applied correctly, subprime mortgages could mean the difference of someone being able to save their home assuming they were able to be disciplined enough to keep (or get) their finances healthy.  This family will not qualify for FHA or FHASecure (they don’t have an ARM that’s adjusted).   What they need is a subprime (now known as "non-prime") mortgage to buy them a little time.   Now their time is running out.

Part of their problem began with working with an unsavory loan originator who is now out of the business.   The LO brokered their loan to a subprime company I would not work with.  (Even though we’re approved with around 80 lenders, give or take depending on the day, I tend to select 5 preferred prime lenders and 3-5 subprime/alt-a…this lender was not on my list of preferred). 

Shortly after closing, their lender informed them that they did not have home owners insurance…they did.  They provided documentation showing their insurance to the lender.    The lender did not respond and instead, ordered insurance for them at a hefty price…jacking up their payment beyond what they can afford.   Now they’re sliding down a very slippery slope and the lender is not cooperating.   They are behind on their mortgage a couple months.  They called out for help too late.   

NOTE:  Other lenders may be more willing to cooperate with homeowners…you need to act quickly and contact your lender if you’re having difficulty with your payment. 

Homeowners:  the very moment you think you may be having trouble with your mortgage or debts, please contact your Mortgage Professional right away.   If you don’t have one, you can always contact your CPA or other trusted financial advisor for a referral.   Please don’t wait until you have a "mortgage emergency"…get help, even if you just have the sniffles.

Trusted Advisors (Real Estate Agents, CPAs, CFPs, etc): Please keep an ear out for your clients who may have adjustable rate mortgages or are may be having difficulites with their mortgage payment.   Even if an ARM isn’t scheduled to adjust for 12 months or more, the sooner someone meets to with a Mortgage Professional to make sure their credit and everything else is in line to restructure the mortgage (if needed), the better for all.

All home owners should meet with their Mortgage Professional at least annually to have a "mortgage check up" or Annual Review.   This is a service that I provide to my clients.  I’ll provide more information about the Annual Mortgage Review in a separate post.   

My point is, the more time you allow yourself to fix a "sick" mortgage situation, the better your odds are of finding a cure.

Refinancing with FHA…now that’s Paris Hilton HOT!

Parishiltonthatshot What?  You’ve never thought of FHA mortgages as “hot”?  Read about this scenario of a client I recently helped and you just might be cooing “that’s hot”, too! [Read more…]

Buying a house when you have a lot of debt

A reader who recently moved to Seattle contacted with a question that I think many will relate to.   He contacted me offering his story:

"One idea you may be interested in writing about are house buying options when you have good credit and income – but a lot of credit card debt. We’re paying off the credit card debt slowly — very slowly, and seeing housing prices rise 15% or more annually. It’s frustrating because as time goes by — the dream house only gets further out of reach. We will be able to buy a nice house — but not the dream house we could if not saddled with the credit card debt. The credit card debt also isn’t tax deductible!"

I work with many families who have visions of their "dream home" while they’re trying to manage monthly debts.   And as if buying a home wasn’t stressful enough on it’s own, many home buyers seem to feel panicked over our local appreciation with home prices.   It’s a definite balancing act of buying as much home you can afford without "betting the ranch".   If you’re over burdened with credit cards AND you take on a hefty new mortgage payment, you could be setting yourself up for financial (and emotional) disaster.   

I do not encourage using a mortgage such as an Option ARM for sole purposes of stretching into your dream home.   If you make the minimum payments (which most will opt for) the deferred interest will reach it’s cap and you will be faced with a much higher mortgage payment.  If you cannot afford the mortgage payment using a fixed period ARM or fixed rate product, you probably cannot afford the home.   

It’s very possible that home buyers may need to redefine what their dream home is.  Buying a home that needs a little TLC or is a little further out from the city may afford you more comfort when it comes to your monthly cash flow.   Plus, you may receive a better return on this type of property should you decide to sell it in 5 or so years, using the net proceeds (profit) to purchase your "dream home". 

Modo3530For example, this 1800 sq. ft. completely remodeled rambler (now subject to inspection) was recently listed in Kent for $349,950.   It’s on a corner lot, in a popular neighborhood with four bedrooms and 1.75 bathrooms.   I’m not a Real Estate Agent, but I would bet that similar homes in Seattle would sell for closer to $500,000.   Having the lower payment and more funds in the bank from a reduced down payment can translate into a higher quality of life.   I know…I know…you do have to factor in commute times with our traffic.   But once you’re home, you are HOME.

I will go into more details about this families information in future posts.   They were gracious to share their information with me and their story is certainly not unique.

Divorce, your mortgage and your credit

Whether you’re married or are a couple who own a home together and are now facing a separation, dissolving a partnership is never easy.   Even if both parties are amicable and agree to the break up, it is a very emotional time.  You may just be thinking about who gets to keep the house…or you just may want out and not even care about the property.   Your mortgage and credit history is probably the last thing on your mind…however, you may want to consider protecting the credit that you’ve worked hard for.   

Do contact an attorney who specializes in divorce.   Even if you just contemplating a divorce and you’re not certain you will file.  It’s important to find out the facts and get legal advice from a professional. 

Obtain your current credit report.   You can get a free copy from    Review it to make sure that your debts are in order and that the other party is not using your credit for “retail therapy”.    Identify which accounts you may want to close if they have your name on them.   The credit company may be all too happy to issue your own card in your own name.    Having an ex-partner with your credit, even if you’re getting along now, can wreck havoc on your scores.   If your name remains on an account they have, even if they pay the debts on time, if the balances exceed 30% of the limit on a credit card, your credit score will suffer too.   

Consider closing any joint accounts immediately that are not in use and removing your name from any accounts that you are a signer on.

Secured accounts, such as loans attached to vehicles and mortgages must be dealt with too.   You might consider selling the items that have secured loans in order to remove your name and liability from the debt.   Otherwise, you should consider refinancing the loan.   Plus, the payments may be factored as your debt when qualifying for new loans, such as a  mortgage.

Should your ex-partner decide they want to keep the house, require that they refinance the mortgage so that your name can be removed from the debt.   Deeding the property from one person to another does not remove the liability of the mortgage.   Even if your partner is a really nice person right now, if they lose their job 5 or 10 years from now, and your name is still on the mortgage, it will dramatically impact your credit if the bills are not being paid. 

If your ex-partner does not qualify for a refinance of the property, then how can you expect them to make the payment?  It’s too risky.   

One of my friends went through a divorce.  Her ex really wanted the house.  He did not qualify for the mortgage on his income alone and wasn’t thrilled when she insisted that he needed to refinance to take her name off of the mortgage.   Although it was a tough decision, they sold the house and split the proceeds.   He remarried and bought another house with his new wife and in just a few years, filed bankruptcy and the home was foreclosed.   Imagine what would have happened to her credit if she would have accepted the cash offer of her share of equity without refinancing the mortgage out of her name?  She would have been responsible and included in the foreclosure.   Her credit would have been trashed and it would be extremely difficult for her to buy a home.   

Should you divorce, your divorce decree will not override your agreements with creditors.   It’s important to be proactive and to always take steps to protect your credit.  Although credit scores are reflective and not permanent, bankruptcy and (especially) foreclosure will impact your credit scores and interest rates for years.

Remember, take precautions with your mortgage, credit history and consult with an attorney if you are considering a possible divorce.

Debt and Your Mortgage

Istock_000002310753medium_3This is the second part of my series on debt inspired by the blog Dollar Buy Dollar.  Before I get too deep into my posts, I want to stress that if you have a mortgage and you are sliding further into debt, please contact your Mortgage Professional as soon as possible.   Don’t wait.  It may feel better to dig your way out without help, however, credit card lates and even worse, mortgage lates, will ding your credit score down to where either:

  1. Your rate for a possible refinance or equity loan is much higher as rates are credit score based.
  2. You no longer qualify for a mortgage at the loan to value you need for debt relief.   (The amount of equity-loan to value-that is allowed to borrower is also credit score based).

I’m not a huge fan for using one’s equity as a cash card.   However if your equity can bail you out of a desperate debt situation and if you are capable of changing your spending and savings habits so you don’t wind up having to tap your equity again, then it makes sense.   

I cannot emphasize enough how important it is to take action right away.  Especially in our current mortgage "subprime" climate where it is tougher to qualify for loans with lower credit scores.  If your scores plumet too low and if you are not able to access  your equity, you may be forced to sell your home.   A mortgage late is more devistating to your scores than a credit card late and any recent lates will zap your score (mortgage lates carry more weight than a credit card late).    Credit is reflective, so the more time since a late payment, the more your score will rebound.

Recently I helped a couple where the homeowner, who was self employed successfuly for over 20 years ran into hardships with his business.   He wound up relying on credit cards to try to "bridge" his lack of income.   In a short period of time, he was not able to pay his credit cards or keep up with his mortgage.   He has a beautiful home valued around $700,000 and a mortgage balance of $250,000.   He wound up with a 120 day late (3 months of not paying a mortgage–preforeclosure).   His then Fiance helped to get him current on his mortgage, he was lucky!   However the mortgage he had was ugly.   The Fiance contacted me about refinancing their high rate subprime loan he was currently in.  She had credit scores over 700 and his were around 400.   In addition to the "preforeclosure" on his mortgage, his credit report was full of collections and late payments.  Here’s what we had to do in order to help this couple in order for them to receive the best rate and program available:

  1. Wait until the 120 day late was 1 year old.  (We were six months away and were waiting for the underlying mortgage’s prepayment penalty to expire).
  2. They married and she was added to the title.   The lender wanted to wait until she was on the title for 6 months before they would close.
  3. He remained on the title (is still a vested homeowner) and is not on the new mortgage.
  4. His judgments had to be paid at closing.  (This was a cash out refinance to pay off all remaining derogotory debts).

We did a no income verifed loan with just her on the mortgage.   The new rate was just 0.25% over the available conforming rates with no prepay penalties.   Bottom line, he was fortunate that when he disclosed his situation to his partner, she was willing to stick around and help bail him out.   He’s also lucky that he owned a home and had enough equity that he could do the cash refinance or, if he had to, sell the home and have enough proceeds to pay off debt and have a savings left over.

If he didn’t have the mortgage lates, we could have refinanced his loan much sooner.     It all worked out for the couple…now newlyweds!   Restructuring the mortgage to eliminate the debts has made a dramatic difference in their lives.   Your Mortgage Professional may or may not be able to help "bail you out".   At the very least, a qualified Mortgage Professional can help you decide which debts to pay first.   I’ll address that issue in my next post for this series.

Watch CNN’s video on Dollar Buy Dollar and couples who hide debt from each other.

Related Post: The Debt Disease…Dollar Buy Dollar; Borrower Beware

The Debt Disease…Dollar Buy Dollar

ShredderThe other morning, I had CNN on as I was getting ready for work when a story about a local blog caught my attention.   Dollar Buy Dollar is authored from a Washington State resident who has found himself in quite the pinch by jacking up his credit card bills and student loans to a total that tipped over $70,000.   The blog is an honest (sometimes painfully honest) account on what he’s doing to try to get out of that mess.   This should be a must read for every senior in high school and anyone with more credit debt than savings.    Debt happens far too easily and, like packing on a few pounds, it’s much easier to gain it than to whittle it away.

The author of the blog is remaining anonymous and calls himself "Fellowes" (like his shredder).    Here is an excerpt from Fellowes most recent post:

  • Taking on debt has become a lifestyle for many people, something that seems to be actively encouraged by our consumerist society
  • Couples hiding/lying to one another about debt IS a huge problem
  • Debt and the seeming inability to pay it down, discuss it openly with your spouse or other members of your family has a HUGE impact on mental health, physical health and family stability
  • There is a tremendous amount of confusion about the “best” way to pay off debt while still maintaining one’s dignity and self-respect.

As a Mortgage Planner, I see consumer’s debts all day long when I’m completing a loan application or reviewing a credit report.   It can be a tremendous slippery slope for a family when your debts exceed your savings.   And with the national savings rate at below 0%, we are in more danger of a credit bubble ready to burst than a real estate bubble (at least in the Seattle area).

This is such an important topic and I personally believe that this issue is more wide spread and impacts more consumers than we know since it is often kept secret, as Fellowes mentions above.   Fellowes is receiving quite a bit of attention from his bit on CNN, many others are confessing their tough situations via comments to his posts.   Fellowes offers this heartfelt advise:

For those of you in the same situation. DONT WANT ANOTHER MINUTE. Overspending, lying and hiding from this can lead to other VERY destructive behaviors that can not only put your marriage at risk, but your life at risk. Go seek professional help if you can’t have the conversation with your spouse, but my all means HAVE the conversation. The hardest part of this whole ordeal was admitting how bad the problem was and that I my behavior was out of control. Paying in down and finding ways to negotiate and save and nickel and dime here and there is becoming a game for me, albeit a fun one. Thanks everyone for your support, suggestions and feedback. I will do my best to chronicle my journey and share other financial musings to keep you all coming back.

I will be following up with a series of posts on this topic.   You can consider this "Part One".