Getting a Mortgage
- Lynette Khalfani

You’ve probably been hearing a lot recently about the shakeout in the sub-prime mortgage industry. Sub-prime lenders, which offer mortgages to people with shaky credit histories, only started operating about a decade ago. They typically offer sub-prime customers mortgages with rates about 2 to 3 percentage points higher than customers with A-1 credit. But now that a slew of sub-prime lenders are facing big losses and even bankruptcy, many observers wonder whether lenders will stop loaning money to those without stellar credit ratings. If you have so-so credit, and are worried about not being able to get a mortgage loan, put your fears to rest. Sub-prime lending is a VERY lucrative market for many financial institutions. I definitely DO NOT think the sub-prime market will disappear overnight because banks can make so much money off of these customers. Yes, some players will get out of the business -- or be forced out due to business mistakes (i.e. making too many loans to too many customers who default). But where weaker players fall by the wayside, stronger, better managed companies -- with more efficient operations and improved lending standards will take their place.

Why Subprime Lending Isn't Going Away?

Another reason the sub-prime universe won’t go away is that some financial institutions aren’t using sub-prime customers merely as huge profit centers. Instead, these banks have made a commitment to increasing the rate of homeownership in poor and urban areas, or among minority and immigrant customers, some of whom fit into the sub-prime category. There is even a federal push to improve homeownership rates in America. When President Bush launched “America’s Homeownership Challenge” he said he hoped to “eliminate barriers to homeownership and increase minority homeownership by at least 5.5 million families by the end of the decade.”

Have The Chickens Come Home to Roost?

Nevertheless, we’re now seeing many sub-prime lenders in serious financial trouble - so much trouble that critics say it looks like the chickens have come home to roost. Initially it was the customer who was paying the price -- with higher interest rates, adjustable rate mortgages, and other “creative” or exotic mortgages they couldn’t truly afford. Now, that pain is spreading from the customers to the banks themselves. Entire companies are folding. In the past year alone, banks have racked up billions in losses and more than 100 banks have gone out of business in the U.S., including many that were heavily involved in sub-prime lending. Customers didn’t pay their loans, and in turn, the finances of these banks became shaky and they wound up going out of business. The latest bank under pressure is New Century Financial. Company executives revealed this month that they are facing a criminal probe and that they are in default on some of their covenants with their own lenders. Also adding to the mix: Freddie Mac, which buys mortgages from banks, recently said that it will no longer acquire certain risky loans that seem practically destined to default.

Advice For Would-Be Homeowners

So what should you do if you want to buy a house, but you’re in the sub-prime category because your credit score is below 620?

1. Start cleaning up your credit immediately. Banks and other lenders are definitely going to get stricter about who they approve for various loans. Previously, sub-prime banks would lend to someone if their credit score was 580 or better. In the future, I expect banks to nudge that score up, and force you to have at least a 600 FICO credit score. (With most banks you need the magical 620 score to qualify for a mortgage loan).

2. Seek out a credit-worthy co-signer for your loan. If you have a co-applicant (a spouse, trusted family member or friend) who can strengthen your credit application, this can enhance your ability to get a mortgage, and perhaps eliminate the need for you to get a sub-prime loan altogether, in favor of a traditional loan with better terms and rates.

3. Make yourself look good on paper. Do what you can to tip the scales in your favor, outside of what your FICO number shows. Remember: lenders like to see stability and good character—that you’ve had the same address, and telephone number for years, and that you’re not just bouncing around from place to place. It can be a big red flag for a mortgage lender if you've rented five different apartments over the past five years. It is also helpful if you remain in the same job for a number of years.

4. Build up your cash reservoir. You may be able to offset a weaker credit profile by coming up with a bigger down payment when you buy a home.

5. Lastly, investigate programs targeting first-time homebuyers and persons with limited credit. Many of these programs offer interest rates as good as -- and in some cases better than -- the mortgage interest rates that can be obtained by people with perfect credit. (See my blog posting from February 21, 2007 for more info on this). 

All these strategies can strengthen your mortgage application and help you achieve the American dream of getting the home you want and deserve -- regardless of whether or not the mortgage industry considers you to be a high-risk, sub-prime borrower. end

Photo by: Steve Cole