Now more than ever, home loans are difficult to obtain for those with subpar credit.

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In the wake of the housing market crash and its subsequent road to recovery, lenders have become increasingly selective about who they qualify for long-term loans. But there are options for those with less-than-stellar credit ratings when it comes to the American dream of homeownership. All it requires is patience, resourcefulness, and a bit of research.

Many previous homeowners fell victim to foreclosure in recent years and took big hits to their credit scores. Now they’re looking for a fresh start, another chance to own a home, despite their grim credit outlook – and it’s definitely not a long shot for them to try again. Even first-time buyers with scarce credit history need a hand when it comes to financing a mortgage. Is there hope for their house hunting?

Improving Credit-Worthiness

For individuals with foreclosures on their records, the average waiting time before  applying for another home loan is approximately two years. This provides ample time for those individuals to repair their credit through active and passive measures such as paying down all debts, stashing away money each month, and maintaining steady employment. Many lenders will overlook a checkered financial past if it appears the potential borrower has learned from his or her mistakes and now exhibits responsibility and stability.

In fact, there are several unexpected things a borrower can do to make up for past financial weaknesses such as being a good employee. If you, for example, have received increases in pay during your time at your current job, lenders see that as a good quality. It shows that someone believes in your integrity and is willing to compensate you for it. Other obvious tactics to improve your financing chances include obtaining a major credit card (if you don’t already have one) and paying all bills on time.

The last and most important thing to do for borrowers with bad credit is to save money, at least 10% of their maximum price range. However, the reality is that most high-risk loans are going to require larger down payments, so saving closer to 25% is ideal. Another option is to simply lower the amount borrowers are willing to finance on a home, which is a smart move anyway. Rebounding from credit is not the opportune time to get back in over your head with a large financial obligation that could be difficult to pay down the road.

Flash forward two years: borrowers have healed their credit as much as possible, maintained a steady wage, reevaluated the amount they should finance, and saved money for a down payment. What next? Apply for a loan.

Financing Options

For the best interest rates, borrowers should apply for conforming loans. These will be more difficult to get for those with bad credit, but they are ideal as they help provide mortgage credit for Americans. Essentially, conforming loans adhere to strict guidelines set forth by Fannie Mae and Freddie Mac, who can buy the loans, package them into securities, and sell them to investors in order to provide a steady flow of affordable home financing funds.

Hard-money loans are widely available for borrowers with low credit scores, but their terms are often less than favorable. These loans require a huge down payment,
often 20-35%, and feature prepayment penalties that force borrowers to maintain the loan for the duration of its term, causing them to pay the fully-inflated interest.

Hard-money loans often have adjustable rates, as well, which can fluctuate down (hooray!) or up (boo!) throughout the loan term based on the prime rate.

Federal Housing Administration (FHA) loans are a dream come true for borrowers with low FICO scores. Essentially, FHA loans reduce the risk lenders face when they
grant financing to individuals paying less than 20% down by insuring the loan.

Perfect for first-time buyers and low- to moderate-income buyers, FHA loans boast minimal adjustment to their interest rate and fund the mortgage insurance directly
into the loan, leaving no out-of-pocket costs.

If borrowers have a positive relationship with a seller, owner financing may be the way to go. Borrowers who inspire trust and confidence in a seller can often get them
to carry the note while they make payments on it. The loan will still be in the seller’s name, but the financial responsibility will fall to the “borrower”, who is essentially
renting-to-own. As such, owner financing can be difficult to obtain since it requires the utmost trust that borrowers won’t default on their financial responsibilities.

However, if you can get a seller to carry the note for you, the terms of the loan and interest rate will often be favorable since you can work them out directly and intimately with the seller.

But before anyone – good credit or bad – takes steps toward home ownership, he or she should ask the most important question of all: Is this the right move for me?

If you’re not ready for the obligation or the risk, don’t take it. Getting financed for a mortgage is a big undertaking not only for borrowers, but for the lenders who guarantee the loans, so avoiding a potentially precarious situation is the best route.

— Jared Diamond is a contributor with HomeStarSearch, an online informational resource on housing for rent to own. Jared writes on topics ranging from personal finance, housing and economics.

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