If your credit is damaged, with a FICO score from 620 to 680, you’ll have trouble getting a mortgage. If it’s poor – 580 to 620 – more trouble. If it is toxic – below 580 – you’re looking at a real struggle. And yet, it can be done, under the right conditions, and with the right lender and loan officer helping you. Here are the three best loans for borrowers in these three credit-score categories, with pros and cons for each. First, though, ask yourself: Is it smart to go further in debt when you’re already over your head? Maybe it’s best to put your financial life back on track before you purchase real estate.

FICO score: 620-680

Fannie Mae

You’ll need at least a 620 FICO score for a less expensive “conventional” mortgage, backed by Fannie Mae or Freddie Mac, the government-controlled corporations that dominate the market. Lenders follow Freddie’s and Fannie’s rules but also set their own score requirements. For some, a 620 score is enough. Others demand higher. Most lenders offer conventional mortgages but look carefully for a lender’s representative willing to take the time and effort to help a low-score borrower qualify.

Pros: Cheaper than other options for low-score borrowers.

Cons: A lower credit score makes it more difficult to borrow. You’ll pay a higher interest rate. You’ll probably need to put 20% down with a score this low.

FICO score: 620-680

Freddie Mac

Freddie Mac’s requirements are similar to Fannie Mae’s.

Be prepared, with any loan, to explain why your credit score is low. Prove that you suffered a one-time hardship over which you had no control – illness, for example, or job loss you didn’t cause. If your score is low because you’re just chronically late paying bills, you can probably forget it, says Eric Mitchell, vice president at Priority Financial Network, a direct lender based in Calabasas, Calif.

Pros: Cheaper than other options for low-score borrowers.

Cons: You’ll pay a higher interest rate. Find a lender representative who will take the extra time to work with your application. You’ll probably need to put 20% down with a score this low. With a down payment smaller than 20%, you’ll have to buy private mortgage insurance.

FICO score: 620-680

Federal Housing Administration

With a lower credit score, the FHA may be your best bet. The FHA’s requirements are more lenient than those of most other lenders. This year, 42% of FHA home-purchase loans (PDF) went to borrowers with credit scores between 620 and 680. The average credit score was 693. FHA borrowers made down payments of 4%, on average.

Pros: FHA-backed mortgages are easier to obtain; most lenders offer them. Down payments can be as small as 3.5%. 

Cons: FHA loans are becoming more expensive. When mortgage insurance is taken into account, an FHA mortgage can be more costly than a conventional loan. Mortgage insurance is required, in addition to homeowners insurance, for as long as you have the loan.

FICO score: 580-620

Department of Veterans Affairs

A credit score in the 580 to 620 range puts you in what mortgage banker Eric Mitchell jokingly calls the “demilitarized zone.”

“There are options, but man, it’s tough,” Mitchell says. “Very few will go below that 620 DMZ. One of them is the VA.”

Ask friends or your VA representative for lenders offering VA loans. The Department of Veterans Affairs guarantees mortgages for qualified active or retired U.S. service members or spouses who meet certain criteria.  Borrowers’ scores typically are at least 620 to 640, but the VA can lend to veterans with scores of 570 or lower who qualify because of exceptional circumstances, such as having been wounded in combat.

Pros: No money down. Easier to qualify. Sellers can contribute to closing costs. Higher debt levels allowed.

Cons: Available only to military veterans.

FICO score: 580-620

Agriculture Department

One of the best options for low-score borrowers is a USDA Rural Development Guaranteed Housing loan. These fixed-income mortgages have terms of 30 to 38 years. Here are the rules. You can have an income of up to 115% of the median income of your area.Check your income eligibility here.

This program is meant for rural areas but the department has a broad definition of “rural.”

Pros: No down payment. Borrower qualifications are looser than for conventional loans through Fannie Mae and Freddie Mac.

Cons: Not available everywhere. Few lenders offer USDA mortgages.

FICO score: 580-620

Federal Housing Administration

If you can’t get a VA or USDA mortgage, the FHA is your best bet in the 580-620 score range. Borrowers with scores of 580 and above can get an FHA-insured mortgage with a down payment of 3.5% of the home’s purchase price. Just 1.6% of FHA mortgages this year were to borrowers with scores between 580 and 620, so be sure to find a loan rep experienced at working with low-score borrowers.

Pros: Requirements are more lenient and interest rates are low. Down payments are as low as 3.5%. Most lenders offer FHA mortgages.

Cons: FHA loans are becoming more expensive. FHA’s mortgage insurance – required in addition to homeowners insurance – makes these mortgages pricier than conventional mortgages.

FICO score: Below 580

Subprime or ‘nonprime’ lenders

These loans don’t qualify for government backing, which makes them considerably more expensive. Nonprime lender Citadel Servicing Corp. in Irvine, Calif., for example, makes fixed- and adjustable-rate mortgages for borrowers with FICO scores as low as 500. For scores of 550 and lower, rates run from 9.75% to 11.25%; market rates are hovering between 4% and 4.5%. Your rate depends on the points you pay and the size of your down payment. Down payments range from 35% to 60% of the loan amount.

To find a subprime mortgage, work with a broker who has earned the certified mortgage planning specialist designation. Ask for references. Watch for “bait and switch” tactics, in which you’re reeled in with an attractive offer but terms are later changed. Financial Firebird Corp., which says it tries to screen out predatory lenders, maintains a national directory of bad-credit mortgage lenders and brokers.

Pros: Mortgages are available for borrowers with scores below 580.

Cons: High down payments, high costs and difficulty locating credible lenders. Expect to pay at least 40% down, Mitchell says. That’s $160,000 on a $400,000 home, for example.

FICO score: Below 580

Federal Housing Administration

The FHA makes a few mortgage loans – less than 2% of its loans this year – to borrowers with scores below 580. You must have a solid explanation why your credit is this low. If you’re one of the lucky few to get a mortgage at this score, be prepared to make a 10% down payment.

Pros: Most lenders offer FHA mortgages. Requirements are more lenient and interest rates are lower. You should find a loan rep with deep experience helping low-credit-score applicants.

Cons: Higher down payment. The FHA makes few loans to borrowers with scores this low.

FICO score: Below 580

Family and friends

Your best option with a score this low may be a friend or family member who is willing to loan you money to buy a home. Learn how to borrow from friends and family.

Pros: No outside qualifications to meet. Terms decided between you and your lender.

Cons: Borrowing money puts your closest relationships in jeopardy. It can be a bad idea. Instead, take the time to dig out of debt and cure your credit. If you must, use a lawyer or a third party such as National Family Mortgage, which specializes in facilitating loans between family members and friends.

(Source: MSN Real Estate)

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