Avoid the Traps of Bad Credit Home Loans

It seems that owning a home is the American dream. However, if you are one of the millions of Americans with bad credit, then you probably though that dream was out of your reach. Lenders have seen the opportunity to offer mortgages to people with bad credit and seized it. Though this may seem like a dream come true for many, you must beware of the traps these bad credit home loans can bring.

One of the biggest traps that new homeowners have fallen prey to recently is accepting an adjustable rate mortgage or ARM. This type of mortgage is great if you are a first time buyer or have poor credit. The adjustable interest rate allows the homeowner to choose their payment—either a low payment that doesn’t even cover the interest, an interest-only payment, or a payment that covers interest and pays down the principal. A homeowner can continue to make minimum payments until the loan balance reaches about 110% of the original principal. If the homeowner is planning to move within a few years, or expects to have a greater income in the near future, then this plan is ideal. The danger occurred when lenders calculated borrower eligibility based on the minimum payment only. Therefore, when greater payments had to be made, homeowners couldn’t afford them. Additionally, with the loan having grown to 110% of the original loan amount, often the mortgage was more than what the house was worth. As a result, many homeowners have had to walk away from their mortgages and their new homes.

How can you avoid the ARM trap? First determine if you can truly afford a new home. Make sure you can put down a decent down payment. Also, if you have bad credit, you may not qualify for the best interest rates on your mortgage. Therefore, you should be confident that you will be able to refinance for better interest rates in the future. If you can’t do these things, you might be better off waiting to purchase a home instead of risking additional credit problems and foreclosure.

Another trap that homeowners with bad credit fall into is being overcharged with fees. There are many fees associated with mortgages but be careful to discern whether they are all legitimate. Sometimes a lender can offer a very low interest rate, but make up the difference in excessive fees. Look out for fees that seem exorbitant or unnecessary. For example, a credit check can cost up to $20 so if a lender or broker charges more than that, you should question it. Be sure to get an itemization of the fees you are being charged and examine them carefully.

Another trick lenders play is called the “bait-and-switch”. The lender first gets you in the door by offering a great deal, such as a low interest rate, small or no closing costs, or a discount on fees. What they don’t tell you is that the deal is only for borrowers with near perfect credit. Many borrowers, once they find out that they don’t qualify, still remain with the lender. You have no obligation to that lender—shop around until you find a lender that will give you what they promised.

Sadly, some lenders incorporate penalties for prepayment into their loan agreements. This means that the borrower will have to pay fees if they don’t keep the mortgage for a minimum amount of time. This is common in mortgages for homeowners with bad credit or ARMs. Be wary and read all paperwork carefully and always ask the lender if you are in doubt.

In order to avoid traps, homeowners need to understand the point system. Points are what the lender charges to offer a mortgage or improve its terms and points usually equal to 1% of the mortgage amount. For example, if you have bad credit, you may be required to provide points to be approved for your loan. One point on a $150,000 loan would be $1500. Instead of paying points, ask the lender how you can reduce the number of points needed or if you can eliminate them all together. This may mean making a larger down payment or having a prepayment penalty written into the mortgage.

Having bad credit can definitely make you more susceptible to home loan traps. The key to protecting yourself is to do your research and remain alert and cautious. Always ask questions about a mortgage that seems too good to be true. Just because you have bad credit does not mean you have to accept a second-rate mortgage. For example, companies like Fannie Mae offer traditional mortgages for people with poor credit. There are even government agencies that can help pay your closing costs. It also may help to seek the assistance of a mortgage broker. They can help find the mortgage that fits your needs if you have financial issues. Additionally, there are mortgage payment calculators online that you can use to see how much you can afford.

Just because you have bad credit does not mean you should be taken advantage of when purchasing a home. You deserve reasonable terms, reasonable fees, and a chance to improve your credit history. A bad credit mortgage does not have to be a negative experience, but should be a step towards the improvement of your credit and your financial future. If you avoid the traps of bad credit home loans, you can achieve the American dream!

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