Regardless of popular belief, there are good mortgage loan opportunities for people with bad credit. In order to receive preferential treatment from mortgage professionals, a credit score of 680 or more is required. If a person has a score less than 600, he/she falls under the sub-prime loan category.
Being in the sub prime loan category, you can get any kind of loan from a sub prime lender. The only difference is: sub-prime loans involve a much higher interest rate, as a risk premium. This means that sub prime lenders believe people with low credit scores risky borrowers because normally their payment history is not good. And since lenders prefer borrowers who have been paying their bills on time, they will charge a much higher interest rate to take the risk of giving you a loan.
Lets go through an example to explain this further.
Let's assume that a borrower has bad credit and wants to buy a home for $200,000. The borrower also has just 5% downpayment available.
This poses a double problem for the lender: bad credit history and a very high LTV (loan-to-value). Usually, lenders would lean towards buyers who are willing to put up 10-20% of their own money as a down payment. This in effect lowers the risk as studies show that the more money a borrower has in a deal, the less likely she is to default.
Now comes in a new term: the borrower's debt-to-income ratio. This is the amount owed per month divided by the monthly income. If this ratio is 50% or less, and the credit score is above 550, it is quite possible that the loan will be approved. However, the downside, as explained earlier, will be the very high interest rate. This in effect means that the monthly payments that the borrower will be making to the lender will be very large.
How to escape large mortgage payments? There are 2 main options.
Reduce the LTV: Instead of taking a loan at a high loan-to-value, split the loan and apply for 2 mortgages. The combined monthly mortgage payment with two loans will probably be lesser than the one mortgage.
Take an Adjustable Rate Mortgage: This will offer great savings, just like conventional loans. If you take a 2-year ARM, which most sub-prime mortgage lenders offer, it possible to get a rate of 5% or 7%.
It is also possible to combine option one and two, and taking an ARM on your first mortgage and still taking a second mortgage for the rest of the amount. This could save you even more.