Self discipline can pay off, even if credit score doesn't

Dear Ms. Mortgage Maven,A few years ago, I became ill and lost my job as a result. Money was tight until I was able to recover and get another job, and as you can probably guess I had some medical bills and other bills that went into collection because I simply had no money. For the last couple of years, I have been trying to improve my credit score and save some money for a down payment. I have skipped movies, dinners out, happy hours, trips, new clothes - you name it - and saved almost $10,000.

The problem is that my credit score is still low. Last time I checked it was around 580. I am getting discouraged. Do you think I can buy something any time soon?

Thanks!

Malika F.

Dear Malika,

I am impressed by your discipline. It is hard to deny immediate pleasures - movies, dining, clothes - in order to save money for a distant purchase. Do not be discouraged about your credit score. All that work on your credit score will pay off one day. But, I do not think you will have to wait to buy a home. I think you can buy a property now, with a loan guaranteed by the Federal Housing Administration (FHA).

FHA loans are gaining traction in today's market, thanks to the demise of many subprime lenders and the updating of FHA's guidelines that remove some unnecessary hoops and hurdles for the buyer. While FHA loans are not meant to replace the subprime market, borrowers with a blemished credit history are more likely to get a loan with a great interest rate.

FHA loans are full documentation loans that generally require a small down payment of 3%. The borrower will have upfront mortgage insurance, meaning that the mortgage insurance amount is rolled into the loan amount, and a smaller monthly mortgage insurance payment than with a traditional loan with mortgage insurance. The debt-to-income ratio for an FHA mortgage is 31% - meaning you can spend 31% of your gross income on your loan, and your total debt-to-income ratio (DTI) cannot exceed 43%. (To calculate you total DTI, tally of all your monthly debts that are on your credit report - car payment, student loans, credit card debt, etc - and divide that by your monthly income. Please know that these ratios are flexible and can be increased for borrowers with high credit scores.)

By way of example, let's say you want to buy a $250,000 condo. You would put 3%, or $7,500 down as a down payment. Your loan amount would be higher than $242,500, however, because you finance the upfront mortgage insurance premium of 1.5% (or $3,637.50) and that gets added to your principle balance (now $246,137.50). If your interest rate is in the low 6% area (realistic in today's market), say 6.25%, your mortgage payment would be $1,511/month, and your monthly mortgage insurance payment would be just over $100. If we add another $500/month for your condo fee and taxes (the condo fee will generally include a master insurance policy for the structure), your total monthly payment would be $2,111. By way of comparison, the interest rate for a Fannie Mae eligible 100% financing transaction (if you had a 620 credit score or higher) would be about one full percentage point higher, or about $160 more each month.

My sense is that with a 580 credit score and $10,000 in the bank to use as a down payment, you will qualify for an FHA loan. Make sure that your real estate agent negotiates to have the seller pay all of your closing costs, because $10,000 will not be enough to cover the down payment and closing costs. You did not say what your salary is, or what other debts you may have, so it is impossible for me to say how much purchasing power you have, but on the face of it you should qualify for a loan.

So congratulations again on the self discipline you have exercised over the last couple of years. I think that you will find there is no need to be frustrated. Sincerely,

Jessica White, also known as "Ms. Mortgage Maven," is a mortgage consultant with Tenacity Mortgage. Call or email her to discuss your home purchase or refinancing needs. She can be reached at 202-607-4449 or Jessica@msmortgagemaven.com. You can also apply online at www.msmortgagemaven.com.