When approving applicants for a home loan, mortgage lenders look for borrowers with fair to excellent credit. Because most borrowers are seeking hundreds of thousands of dollars, the overall belief system is: “If a borrower can’t properly manage smaller debts, why should we trust them to manage a much larger debt?
A car repossession is one of the worst things to have on your credit report for mortgage lenders.
- It’s a secured loan (similar to how a home loan is secured by the property you purchase), and
- Similar to a home loan, It’s an installment loan.
When reviewing your credit data, lenders like to see how well you manage other forms of credit similar to the type of loan they plan on extending to you.
If you show that you can’t handle your financial responsibilities – in this case a repossession – it does create a stain on your report. A repossession remains on your credit or up to 7 years. That’s a long time. Fortunately, you do not have to wait that long to be approved for a home loan.
What options do you have?
We’ll explore how a repo affects your credit, what mortgage lenders look for, and how you can make up for the issue and get a home loan.
How a Repossession Affects your Credit
Most car lenders won’t repossess cars until you are more than 90 days past due and after diligent effort to help you become current again.
If you don’t rectify the situation, they take the car and report it the repossession to the credit bureaus. Because the previous late payments were already reported, the actual repossession itself may not impact your credit scores that much. If the repossession occurred without the reporting of the previous late payments, depending on your credit score before the repo, you could lose as much as 100 points. If you already had ‘bad’ credit when any of the negative reporting associated with the repo hit your credit reports, your scores may not be impacted by that much, however, remember: The repossession record can remain on your credit report for up to 7 years.
What Credit Score do Mortgage Lenders Consider ‘Bad’?
Mortgage lenders look at your credit score first. If your credit score is too low, they won’t move forward with your application. Each loan program has minimum credit score requirements. They may vary by lender, but general program requirements are as follows:
- Conventional loans – 660 credit score (can be as low as 620)
- FHA loans – 580 credit score (can be as low as 550 with a 10% down payment)
- VA loans – 620 credit score (can be as low as 600)
- USDA loans – 640 credit score (can be as low as 600)
Again, the scores below are the general accepted scores; meaning: Every conventional lender will not accept a 660 credit score, and every FHA lender will not accept a 580 credit score; and so on. Each lender will at the ‘big picture’, starting with your credit reports and scores. If you have a recent repossession, chances are your scores will fall between the 580 – 620 credit score range (or lower). If your repossession is older, as long as you have properly rebuilt your credit and maintained stellar payment history since the rep occurred, you may be all good! good!
Looking Beyond the Score…
Fortunately, lenders look beyond an applicant’s credit score. They look at your credit history, employment history, savings, and more.
Remember, I mentioned the age of the repossession? Typically, if a repo is 2 years or younger, you can expect lenders to look the other way or have other requirements to determine your risk level.
If the repo occurred more than 2 years ago and you can prove you overcame the situation, they may offer a loan with specific terms. Typically, you’ll pay a higher interest rate and origination fees to make up for the risk.
How to ‘Make up’ for the Negative Credit Event
Whether lenders will approve your mortgage application after a repo depends on your ‘other qualifying circumstances’. How did you overcome the situation? What explanations do you have?
Here are the top ways to prove to a lender you are worthy:
- Make sure all credit lines you have currently are up-to-date (paid on time)
- Keep all credit balances at less than 20% of your credit line
- Don’t apply for new credit, manage what you have
- Have at least 3 – 6 months of reserves (mortgage payments) available in a liquid account
Most importantly, write a powerful Letter of Explanation. Why did you lose your car? What were the circumstances that you couldn’t control?
Next, explain how you overcame it or show how it was a one-off event. The pandemic is a great example. NO ONE saw this coming. If you lost your job or fell ill and were knocked to your knees, it’s likely a one-off event. Show how you overcame it. What did you do to make good on your debts, even though you couldn’t save your car?
In other words, how have you overcome the situation, and why are a good risk now?
Home Loan Options for Bad Credit
No matter how good your Letter of Explanation is or how much you’ve improved your credit, lenders will still see you as a risk. This doesn’t mean you’re doomed and will only get the worst loan terms out there.
It does mean you probably won’t get approved for a conventional loan (Fannie Mae/Freddie Mac), but that’s okay! Government-backed loans are great options too.
FHA loans are the conventional loan alternative. You only need a 580-credit score (in most cases) and they allow higher debt-to-income ratios. To top it off, you only need a 3.5% down payment.
What’s the tradeoff?
You’ll pay mortgage insurance for the life of the loan if you put down less than 10% down payment. If you put down more than 10%, you’ll pay for mortgage insurance for up to 11 years. You can, of course, refinance in order to eliminate the mortgage insurance completely; which many of our clients and students do once we help them to improve their credit scores.
If this is your ‘forever’ home, purchasing now and refinancing later is worth considering. If you will move in a few years, though, just pay the mortgage insurance and don’t refinance – there’s no sense in paying closing costs again for a home you won’t live in much longer.
Don’t Give Up
If you lost your car in a repo, pick up the pieces and move forward. Yes, it stinks, but it shouldn’t ruin your financial future forever. It will sting the most for the first 2 years. Most lenders won’t touch your application until you hit that 24-month mark. In the meantime, do what you can to improve your credit. You’ll increase your chances of approval not long after you lost your car!