Bad Credit Mortgages
Homeownership is part of the American dream, and many people view purchasing and owning a home as an exciting and rewarding experience. However, buying a home is an investment, the largest single investment most people will make in their lives. Because of the financial significance of buying a home, particularly in today’s real estate market, consumers need to think carefully before deciding to buy a home. There are many pros and cons associated with ownership. Buyers should weigh each of them carefully before deciding if this is the right financial investment decision.
The advantages and disadvantages of home ownership can be measured by the financial benefits versus the financial burdens this type of large investment will provide. Many first-time homebuyers are naïve about the total costs associated with buying and owning a home. For that matter, many homeowners seeking to upgrade to a larger or nicer home, get caught up in the “fun” and forget about the expenses involved in selling, buying, and moving.
Knowing all of the financial obligations involved in homeownership will help buyers make the best decision for their financial situation. Furthermore, consumers with bad credit need to understand these costs because it is more expensive for them to borrow money than consumers with good credit. Understanding the finances of home ownership can make homeownership either more or less appealing. This makes researching options and reviewing information critical for consumers, to ensure they make the most advantageous financial decision.
The Cost of Borrowing Money
The first consideration is the actual cost of borrowing money to buy the home. After negotiating the purchase price, the buyer would need to know the interest rate to calculate the monthly payment and understand the total cost of the loan.
The interest rate is the price the bank, financial company, credit union, or other lender charges for the loan. The interest rate is typically stated as the annual percentage rate (APR). There are various rates of interest and types of rate structures offered, and each determines the amount of money the borrower will ultimately pay for the loan.
The loan amount and the interest rate lenders charge together determine the monthly payment amount. In addition to the interest rate, lenders charge other fees to create a new loan. Some of those fees include loan origination fees, closing costs, and points, also called prepaid interest or loan discounts.
Lenders charge a loan origination fee to recoup the administrative costs associated with processing the loan request. Included in these costs are underwriting or application fees. Lenders can charge either a flat fee or calculate the fee as a percentage of the loan amount. Borrowers should ask upfront what the lender charges and shop around for the best option. Lenders earn a considerable amount of revenue from fees each year because consumers don’t realize they have options. There is no benefit to the borrower for paying these fees, they are not tax deductible so it is beneficial to pay the least amount possible.
Borrowers can pay points or loan discounts to reduce the interest rate on the loan. Loan discount means the borrower pays a one-time fee or portion of interest upfront, so that lender lowers the interest rate. The payment is tax deductible because it is an interest payment. However, it is advantageous only if the borrower expects to live in the home long enough to gain a financial benefit from the upfront interest payment. It is advisable to consult with a tax professional to understand the best options.
Interest, Loan Term, and Credit Score
The price of the loan can vary greatly depending on the overall risk of the transaction, including the credit worthiness of the borrower, the term of the loan, and the type of loan. Other factors can also affect the risk associated with the transaction, such as the percentage of the down payment. All of these factors are taken into consideration when the lender sets the interest rate.
Two of the most common loans are fixed rate mortgages with either a 30-year or 15-year term. The loan amount and the rate determine the monthly payment, which includes payment of interest and repayment of principal. Generally, the longer the loan term, the higher the interest rate. Additionally, the lower the credit score of the borrower, the higher the interest rate. The following is a comparison of hypothetical loan rates for excellent to poor credit scores with both 30- and 15-year loan terms:
30-year, $300,000 Loan
The above chart shows that for a 30-year mortgage, a person with excellent credit would pay 3.73% interest compared to an individual with very bad credit who would pay 5.32%. The difference in interest rate translates to a $284 difference in their monthly mortgage payment, and, over the life of the loan, the borrower with very bad credit will pay $102,082 more interest than the borrower with excellent credit.
15-year, $300,000 Loan
For a 15-year loan, the interest rate for an excellent credit score would be 3.14% compared to 3.73% for a 30-year mortgage. While this does not appear to be a significant difference, over the life of the loan, the borrower with the 15-year loan will pay $122,675 less interest than the borrower with the 30-year loan. In order to achieve that savings, the borrower must pay a monthly mortgage payment that is $705 more than that which the 30-year loan requires.
A borrower with very bad credit will pay a higher interest rate equal to 4.47% for the 15-year mortgage loan in the example, which will translate to a monthly payment of $2,290 or $199 higher than the person with excellent credit. The difference the consumer with very bad credit will pay in interest over the life of the loan compared to the borrower with excellent credit would be $35,833.
These examples, using hypothetical interest rates, demonstrate the significant affect credit ratings have on the cost of borrowing and the cost of credit based on the loan term. The shorter duration loan and the higher credit rating will provide less costly options for consumers.
However, one thing is consistent across all types of loans and rate structures: consumers with bad credit always pay more than consumers with good credit. Furthermore, there are more costs associated with home ownership then simply interest on a home loan. Consumers need to consider all costs association with home ownership to compare the true cost of ownership versus renting in today’s market, particularly if they have bad credit.
The Cost of Purchasing a Home
There are many costs involved in the purchase of a home in addition to the monthly mortgage payment. At the start of the borrowing process, consumers must pay several fees and services for various steps in the purchase process that can add up to a significant investment.
When thinking about buying a home, consumers need to save enough to make a down payment. Though requirements vary, it is in a buyer’s best interest to have twenty percent for a down payment. This is beneficial for two reasons: first, lenders view a twenty percent down payment as a lower risk loan because it is a lower loan-to-value (LTV) ratio. The LTV ratio reflects the percentage the lender has financed versus the value of the property. If the buyer invests twenty percent or more of their money, the lender has a 80 percent LTB ratio and views this as a lower risk, meaning the lender is more likely to get their money back if the borrower defaults. Also, the borrower is less likely to default. On a $300,000 home, a borrower would need $60,000 for a down payment for the lender to meet the 80% LTV level.
In addition to the down payment, borrowers pay for other professional fees that can add up to hundreds or thousands of dollars, such as home inspections and legal services, in addition to the lender fees and closing costs.
Fees to Close the Sale
The process of preparing paperwork and documentation to transfer and record ownership of real estate requires many professionals and their attendant service fees. The Borrower and Seller sometimes share these costs, but many of the fees outlined below are borne by the borrower alone. Some can be rolled into the mortgage and financed over the life of the loan, while others must be paid at the time of closing.
- Appraisal fees: The lender must obtain an impartial valuation of the property before the final approval of the loan. This appraisal is an estimate of the fair market value, and an independent, certified and licensed appraiser must provide it.
- Credit report fee: Lenders order the borrower’s credit report twice during the loan approval process. The first credit report helps the lender to determine the borrower’s eligibility and set the interest rate at the beginning of the process. The lender orders a second report to ensure the borrower’s status has not changed materially before signing the loan.
- Inspection fees: If the purchase agreement contained contingencies requiring repairs, the lender may require an inspection prior to closing to verify satisfactory completion of the work.
- Private Mortgage Insurance (“PMI”): When a borrower pays less than a 20% down payment on a home, they are considered a “high risk” borrower. As such, lenders require that high risk borrowers purchase private mortgage insurance. At the time of closing, many lenders require a PMI application fee and either a portion or a full year of premium.
The premium is typically one-half of one percent of the loan value. For example, on a $300,000 loan, one percent is $3,000, one-half of one percent is equal to $1,500. On a monthly basis, the borrower will have to pay an extra $125 until they reach a loan-to-value (“LTV”) ratio of 80%. PMI is an insurance product that protects lenders from loss if the borrower defaults on the loan, i.e. goes into foreclosure.
Borrowers should become familiar with how their loan payments are applied. When LTV ratio reaches 80%, they should contact their lender and request that the lender remove PMI. Lenders are required by law to disclose PMI costs at closing, as well as inform borrowers of the estimated date when LTV of 80% will be reached. They are also required to cancel PMI at LTV of 78%. For more information about PMI, read the Homeowners Protection Act of 1998 on the Federal Reserve website at http://www.federalreserve.gov/boarddocs/supmanual/cch/hpa.pdf.
- Mortgage Broker Fees: If a borrower used a mortgage broker to obtain the best rates for their loan, they would need to pay the broker at the time of closing. Mortgage broker fees can be either a flat fee or a percentage of the loan, it all depends on the agreement the borrower makes with the broker, state regulations, and other factors.
- Title Fees: The title to real property has to be searched, examined, and other work needs to be accomplished to ensure there are no problems with the title to the real estate. Additionally, title insurance is also purchased to ensure there are no encumbrances with the title to the property that will harm the buyer or lender. A professional who specializes in title work must prepared this documentation and these fees are payable at the time of closing.
- Closing Fees: Closing fees cover a variety of work that needs to be accomplished to prepare documents to close the sale. A third party is typically hired to do this work, and their fee is payable at the closing. Often, these fees are split between the buyer and the seller and can amount to tens of thousands of dollars. Buyers can select a company or use the company the lender recommends. If they shop for a better price, they may save some money.
- Legal Fees: Either the buyer or seller may have an attorney handle preparation of the title work and all or a portion of the closing documents. These costs would either be split between the two parties or paid by one or the other.
- Recording Fees, Transfer Taxes, Document or Transaction Stamps: Buying a home is a significant financial investment for the homeowner, and it is a matter of public record. The property information and the loan information are required to be filed at the county courthouse or other local government recording office. These are government charges based on the amount of the mortgage and, often, also on the purchase price. The recording fee is paid to a government body which enters an official record of the change of ownership. These fees must be paid at the time of closing.
Interest and Pre-payments
Lender may require borrowers to pay fees or interest in advance, which will become part of the total amount due at closing. These can add up to thousands of dollars and may include: the first month’s interest payment, the first year’s mortgage insurance premium (PMI), and / or flood insurance premium, and / or hazard insurance premium may be due at closing. Hazard insurance, also called homeowner’s insurance, is mandatory; it protects the lender and homeowner against loss due to fire, natural disasters, and damage, loss, or theft. Either a portion of the annual premiums or the entire annual premium for each policy is due at closing.
Borrowers are required to carry a homeowner’s policy for the duration of the loan. Any lapse in coverage can be viewed as a default by the lender. The lender can then choose to either foreclose on the property or purchase a policy for the borrower and charge them for it. This would not be in the best interest of the borrower; these policies typically cost 40 percent more than the premium would be for insurance they obtain on their own. It’s in the borrower’s best interest to keep their homeowner’s policy current.
Property taxes are an expense of home ownership that cannot be avoided. Many home buyers neglect to take into consideration this large expense and therefore, don’t budget for it or even inquire about it when determining if a home is affordable. During closing, the property tax obligation for the purchase year is split between the borrower and the seller, based on the date of purchase. The seller settles their obligation with the buyer, but the buyer will pay the full tax on the due date.
Escrow / Impound Accounts
Borrowers can elect to use escrow or impound accounts to pay for property taxes and other large expenses, like homeowners insurance. Escrow, or impound accounts, are used for that purpose. Escrow accounts are set up by the lender and borrower so that the buyer pays a portion of the tax and insurance each month, rather than saving on their own throughout the year. At the time these payments are due, the lender makes the payment on the behalf of the borrower.
This can work for borrowers who have difficulty saving up large sums of money. The down side of this arrangement is that there is a reserve the lender adds to the escrowed amount, which can vary lender to lender. The borrower must ask their lender specifically what that reserve is to ensure they are not putting money into an account that they could use for other expenses. Additionally, there are times when the lender fails to pay the insurance and taxes by the due dates, which causes the borrower problems. Although they have provided the money to pay these items, and the lender agreed to pay them, the borrower is ultimately responsible and will be penalized if they aren’t paid on time.
There are a myriad of expenses related to home ownership. The monthly mortgage payments, homeowner’s insurance, and property taxes are the three largest items that amount to tens of thousands of dollars for an average home. Many buyers stop there, and think no further about the costs associated with home ownership. That is a mistake many first-time home buyers make because they are often naïve about what is involved in home ownership. It is easy to get swept up in the excitement of buying a home. However, there are many costs in addition to the monthly mortgage payment that buyers are often unaware of, and that can cause them financial struggles after they sign the contract.
Before deciding to purchase a home, buyers should compare the costs of owning and renting to determine the best option for their financial situation.
Owning or Renting
There are many costs associated with owning a home that consumers may be unaware of, but they are important to know and should factor into consideration when before buying a home. There are advantages of ownership, such as tax-deductible expenses like property tax and mortgage interest, but many expenses related to home ownership are not tax deductible. Furthermore, while the expenditures amount to thousands of dollars, the tax refund associated with these expenditures is typically only about 30 percent of the actual cash outlay. After careful analysis, consumers would have to decide for themselves if it is more advantageous for them to pay those expenses and obtain a partial return on their money in the form of a tax refund, or keep their money in the bank.
While mortgage interest and property tax are probably the largest expense items for homeowners, there are other costs associated with homeownership that should include in their calculations when determining the economic feasibility of buying a home.
- Maintenance and Repairs: Every home, whether brand new or decades old, requires regular maintenance. Lawn care, landscaping, gutter and roof cleaning are all necessary to keep the property and structure in top condition. Homeowners can do the work themselves or hire service providers. Regardless, these expenses cannot be avoided. If the home is a condominium or in a community where the homeowner’s association takes care of the exterior of the home, the cost to the homeowner will be monthly fees.
All repairs to the structure itself are the responsibility of the homeowner, including elements of the home, such as plumbing, appliances, heating and cooling units, and roofing. If a homeowner is handy, they may be able to save some money by doing the repair work themselves. If not, the cost of repair services, new appliances, and parts can add up to hundreds or even thousands of dollars a year. Typically, maintenance and repair costs are not tax deductible.
- Community Association Fees / Homeowner’s Association Fees: Owners with condominiums, and homes in communities with homeowner’s associations, are responsible to pay association fees either monthly, quarterly, or annually. These fees can range from a few hundred dollars to several thousands of dollars a year. These fees are not tax deductible.
- Homeowner’s Insurance: Lenders require borrowers to carry a hazard insurance policy, also called a homeowner’s insurance policy. This protects the lender against loss due to natural disaster or other damage to the property. The policy is not an option. If a borrower allows their policy to lapse, lenders may consider it a default of the contract. The lender can opt to either foreclose on the property or purchase a policy on behalf of the borrower and charge them the premium, which is typically much higher than a privately secured policy. Premiums for homeowner’s insurance vary depending on the state, the value of the property, and other factors, but can range from several hundred to several thousands of dollars a year. This insurance is not tax deductible.
- PMI: Private mortgage insurance (“PMI”) is required when the borrower makes a down payment less than 20 percent of the loan. This insurance protects the lender, not the borrower. However, the homeowner pays for the policy. The premium can be expensive, anywhere from several hundreds of dollars to thousands of dollars, depending on the value of the home. Once the homeowner reaches 20 percent equity, they can drop the PMI, so it is not a permanent cost. This expense is not tax deductible.
- Other Costs: There is a myriad of other costs associated with homeownership, from pest control to fence repair, all depending on the features and age of the home. Aside from taxes and interest, most do not benefit homeowners in the form of tax deductions.
Comparing homeownership to renting, most of the above costs are either included in the rent or are considerably less than what a homeowner would pay, such as renters insurance. Renter’s insurance protects the renter’s property and any injuries to guests visiting the tenant on the rented property. These policies are relatively inexpensive and are not mandatory. Furthermore, many rentals bundle electric, cable television, and internet connection costs into the monthly rent.
Renting can be an attractive alternative for consumers with bad credit. They can save money and pay down debt, rather than incur the additional expenses of homeownership, the most costly being the price of borrowing money.
Not only is buying a home a big financial commitment, it is also a lifestyle choice. Buying a home means planting roots. Renters can pack up and move whenever they choose; that’s not the case with homeowners. They need to plan well in advance to either put their home on the market to sell or rent. Alternately, they can abandon their home with significant financial consequences.
When homeowners choose to sell their home, they learn how expensive it can be to pay for real estate agents to market and sell the property as well as pay for the closing costs associated with the real estate transaction, none of which are typically involved in renting property.
Renting a home, condominium, or apartment provides flexibility because a consumer can move with few hindrances. The costs associated with renting are typically the required up front rent payments and security deposit, which is refundable if the tenant has caused no damage to the property. The requirements depend on the rental company and the laws in the state where the property is located.
If consumers shop around, they can find good prices on rental units or rental homes that include all maintenance, appliances, lawn care, pest control, and other maintenance and services that are normally paid by homeowners. The advantage of renting is that renters pay rent, someone else has the financial responsibility for all the other costs associated with the property. Renting provides fewer financial burdens and more flexibility. An additional benefit of renting for consumers with bad credit would be having the ability to improve their credit and save money.
Real Estate as an Investment
Before the economic downturn, most people probably would have agreed that buying a home was a good investment. Today, consumers may have a different perspective. Many homeowners have lost their homes in foreclosure or are struggling to make their mortgage payments on homes valued below the outstanding balance on their mortgage.
When purchasing those homes, borrowers held the misperception that real estate is a sound financial investment that will never produce a financial loss. They were unaware that many of the most powerful banksters were willing to lie, cheat & steal to blow a real estate bubble that destroyed people's lives.
Like any investment, real estate is not guaranteed to increase in value, or even hold its value over time. However, over the long-term, real estate is most likely a good investment that by in large tracks longterm wage inflation. It should not be viewed as a short-term, get rich quick, or get a quick return on investment type of transaction. Although that may happen for some people, it is not the norm. Buyers should be cautious. When viewed as an investment, it does have tax advantages such as deferred taxes, but it is not a highly liquid asset. It is an investment that buyers should pursue after careful consideration.