- The Washington Times - Friday, September 5, 2008

Q. I am entering my third year as an owner of a restaurant in Montgomery County.

Starting the business sucked up all of my savings and I was unable to make payments on about $30,000 in student loans and $15,000 in credit card debt. Over the last year, our sales have doubled and I am now able to start paying myself something.

I am paying $800 per month to rent an apartment and hate the idea of throwing this money away in rent. Now that the restaurant is on its feet, I want to buy a home. I spoke with a real estate agent who told me to contact a mortgage lender. I went to my bank and the loan officer pulled my credit report. He said my credit score is 526 and my student loans and credit card balances are past due. The bottom line is he can’t help me.

It seems to me that I would be a good candidate for a mortgage now that my business is doing well. Even though I have some past due bills, there are a lot of accounts on my credit report that were paid off. Can I get an FHA loan so I can stop throwing my money away in rent? Any other advice?

A. Don’t shoot the messenger, but let me tell you like it is in straight talk. First, having past-due debt is far worse that the occasional late payment. A late payment might suggest a temporary cash crunch or sloppy bookkeeping. A past-due account suggests that the borrower, for whatever the reason, simply stopped paying his bill. Lenders don’t like that.

Second, a credit score of 526 isn’t marginal. It’s terrible. However, it doesn’t surprise me because past-due accounts have serious negative effects on a credit score.

While I congratulate you on your recent success in business, you are jumping the gun in the notion to buy a house. Your e-mail doesn’t address how you might have a plan to get back on track and begin to pay off your debt. This, to me, indicates that you don’t have a full understanding of what debt is.

If someone lends you some money, the lender will charge an interest rate and expect to be paid back under certain agreed-upon terms. Your credit report indicates that you have not met the terms agreed upon with your creditors, for whatever the reasons.

Now let’s empathize with the loan officer at your bank. He pulls your report and sees you stopped repaying your loans, yet you are applying for more debt without a plan to pay off the debts that are already past due.

What’s wrong with this picture? Two or three years ago you may have found a mortgage lender who would make you a loan under these conditions. It was called a “subprime” mortgage. Greedy investors happily purchased these loans from mortgage companies because, to compensate for a borrower’s bad credit, the interest rate and fees were much higher. Wall Street loved high-yielding mortgage money.

Herein lies the disconnect that caused the collapse of the subprime mortgage market: No matter how you slice it, high-interest-rate mortgage money lent to folks who have a history of not paying their bills has a high probability of not being repaid. It doesn’t take an Einstein to understand this simple concept, but Wall Street’s vision was clouded due to the dollar signs in its eyes, thanks to the high yield of these mortgage investments.

The subprime mortgage market was a train wreck waiting to happen.

Let’s get back to your situation. While loans guaranteed by the Federal Housing Administration (FHA) are accepting applicants with less than perfect credit, I believe you may have some trouble getting approved for an FHA loan. Even if you could obtain a loan approval, my advice is to take a step back, formulate a plan to get your current debt on an acceptable payment plan and have at least a year of timely and responsible debt payments under your belt before revisiting the idea of buying a house.

* Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail at henrysavage@pmcmortgage.com.

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