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Success with Subprime
by Brian
Sacks
Do you have a question for Mr. Sacks? E-mail
it to brian@loanofficersuccess.com.
Click here
for more articles by Mr. Sacks.
Evaluating the Borrower's Credit History
The borrower's past attitude toward credit obligations is one of the best predictors
of that borrower's future actions regarding debt payment. Thus, the borrower's credit history is important.
A borrower who has consistently made payments on time is likely to continue to
do so and is, therefore, usually a low risk. On the other hand, a borrower who, despite adequate income, has a
history of slow payments, delinquent accounts, or judgments, is a much higher risk.
For such a borrower, the lender would want to carefully analyze the reasons for
the poor payment history. Is it because of poor money management? Or, is it because of unusual circumstances (such
as an accident or a dispute with the creditor) that were beyond the person's control?
When evaluating a credit history, the lender must pay particular attention to
the following:
- Rental or mortgage-payment history
- Recent debts and/or undisclosed debts
- Collections and judgments
- Mortgage foreclosure in the past
- History of bankruptcy
It might surprise you to know that FHA does not require a minimum credit score.
However, a lender might have a minimum. So, when a lender says, "Oh, we can't give an FHA loan with a score
that low," it's not FHA setting a minimum, it's the lending company.
Bankruptcy
A bankruptcy, in and of itself, does not disqualify an applicant for an FHA-insured
loan. The lender must gather complete information about the circumstances of and reasons for the bankruptcy and
consider that information when assessing current creditworthiness. The type of bankruptcy should also be considered.
Chapter 7 Bankruptcy
For an applicant who has had a Chapter 7 Bankruptcy (liquidation), the guidelines
state that the amount of time that has passed since the bankruptcy was discharged is an important consideration.
Two years is the usual acceptable amount of time that must have passed. However, if the applicant can show extenuating
circumstances, then one year from the date of discharge might be acceptable.
Extenuating circumstances can include job loss, prolonged strike, non-covered
medical bills, etc. The circumstances must be verified. Divorce is usually not considered to be beyond the control of the applicant; however, certain circumstances created
by a divorce might be considered extenuating.
In either case, there must be no new derogatory information for at least one year.
If the bankruptcy has been discharged within the past 12 months, it usually will
not be possible to determine creditworthiness.
Chapter 13 Bankruptcy
A Chapter 13 bankruptcy does not have to have been discharged for the applicant
to qualify for an FHA-insured loan. If the applicant has filed for a Chapter 13 bankruptcy, that indicates that
the applicant has made or is making an effort to pay creditors.
If the applicant has made all payment satisfactory the lender may conclude that
satisfactory credit has been reestablished. If the applicant has made at least 12 months worth of payments on time
and the trustee or the bankruptcy judge approves of the new credit, the lender may conclude that the applicant
is creditworthy. The applicant must also get a letter from the trustee saying that the loan will not adversely
affect the repayment plan.
Consumer Credit Counseling
Because consumer credit counseling is sometime viewed the same way as is a Chapter
13 bankruptcy, the guidelines are similar. The lender needs to see a 12-month payment history from the credit-counseling
agency showing satisfactory payments and a letter from agency saying that the loan will not adversely affect the
applicant's ability to repay current debts.
Foreclosure
Generally, three years must have passed since a foreclosure (or a deed-in-lieu of foreclosure) before a person
can get an FHA-insured loan. (For a HUD-insured loan, it is three years from the date the claim was paid by HUD.)
However, if the foreclosure of the borrower's principal residence was the result of an extenuating circumstance
beyond the borrower's control, and the borrower has reestablished credit, an exception may be made. (Also, if HUD
insured the loan and the home was included in a bankruptcy that was discharged – and the bankruptcy was due to
extenuating circumstances – the person might qualify for an FHA loan.) Extenuating circumstances do not include
the inability to sell a house when transferring from one area to another.
Here's an example of an extenuating circumstance:
I had a couple come in to apply for a mortgage. The gentleman was a captain
with the fire department in Baltimore. His wife was a secretary. They had bought a house with an FHA-insured mortgage
in a nice working-class neighborhood. They had lived there happily, raising their child for several years.
All of a sudden the neighborhood turned. There were drug dealers, prostitutes,
and shootings. One day he came home and there were bullet holes in his living room, the windows were shattered,
and there were needles on his steps. He packed up his family and the left to go stay with his wife's parents. He
let his house go into foreclosure and filed for bankruptcy. A year later he came to me for a mortgage.
He got me a settlement sheet, he downloaded statistics and stories from the
newspaper about the decline in his neighborhood, he got a police report about a shooting two doors down from his
house, he got crime statistics for his specific block, and he got newspaper and police reports about the incident
that occurred at his house on the day he left.
The house had depreciated from the $78,000 he had paid for it to less than
$30,000. He brought evidence that he had tried in good faith to sell the house, and comps showing what houses in
the neighborhood were currently selling for. All of the documentation that he had gathered clearly showed extenuating
circumstances, and he was able to qualify for an FHA-insured loan.
Note: FHA does not arbitrarily require collection accounts to be paid off in full.
Click here
for more articles by Mr. Sacks.
Visit Brian Sacks's web site at www.loanofficersuccess.com.
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