Secrets to Getting a Government-Backed Loan

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Brandy and Tom Donahue, who always pay bills on time, didn't qualify under today's strict guidelines for a government-backed VA or FHA loan because of credit mistakes that were more than 10 years old. Even though the Veterans Administration doesn't require a specific credit score, banks now have set stricter rules.

When they tried to get a government-backed loan last year, all the Donahues could find was a higher-cost, adjustable rate mortgage. "We were told we needed a 690 credit score when we didn't realize a credit score was required," Brandy Donahue said.

Tom, a police officer and veteran, and Brandy, a teacher, were told by their mortgage broker that after making 12 on-time payments they could streamline the loan into a lower fixed-rate mortgage. After the year was up, their broker had more excuses as to why they didn't qualify for a government-backed loan, so the Donahues started shopping for a new broker.
The Donahues' experience -- of being refused government-backed loans because their credit scores weren't high enough -- is common today, as banks impose lending restrictions that are higher than those required by the FHA or VA.

While the official rule set by the FHA is that you must have a credit score of at least 580 to get a low down payment loan, many large banks require a credit score of 640. Eric Kandell, a branch manager for Flagship Financial, which specializes in FHA and VA loans, says some smaller banks will take a loan at 620.

Brandy Donahue said that a broker at Flagship Financial was "very knowledgeable about everything." He explained that her credit score was fine but her husband's score needed to be about 640. So they worked with Flagship Financial's credit repair partner, VA Credit Solutions.

You can't go blindly to a bank and apply for a government-backed mortgage loan today and expect a banker to help you, so here are ways to help yourself:


1. Check your credit report

Flagship's Kandell recommends that your first step should be to get your credit reports from all three credit bureaus (Equifax, Experian and Transunion). You can order them for free at the government-run website Annual Credit Report.com. This is the only website that offers free credit reports with no strings. (Other sites might offer you a free credit report but require you to sign up for monthly services.)


2. Challenge credit-report errors

When a Flagship credit-repair specialist took a look at the Donahues' credit report, she found many corrections that needed to be made, including information that was 10 years old or older and should have been left off the report. Brandy Donahue said that the credit-repair specialist then developed "dispute letters for all three bureaus to clean up the reports."

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Examine your report and send a dispute letter to correct any problems. The credit bureaus have 60 days to correct the report, after which you should receive a corrected copy. (Also see "Disputing Credit Report Errors."


3. Be persistent

As the Donahues found out, sometimes you have to send a dispute letter several times to get the correction done. Sixty days later many of their disputed items were still on their reports and their credit score still was not high enough, so another round of letters were sent. During this correction period, you can watch (for free) what happens to your credit score at Credit Karma.com.

In the end, Brandy said that she had to send "three disputes before the critical information was dropped."


4. Order your credit scores

Once your report is accurate and you think you're ready to apply for a mortgage, order your credit scores at myFICO.com. That way you will see what your potential lenders see. if your score is over 640, most banks will approve a VA or FHA loan. If it's below 640, you'll need the help of a specialized broker.


5. Securing a loan

Kandell recommends that you work with a broker who can look for the best placement for your government-backed loan based on your financial situation. Brokers work with more than one financial institution and have a better chance of finding you the lowest cost loan.

If your scores are too low, he recommends that you find a family member (such as a parent) who is willing to sign as non-occupant co-signer. The FHA does allow family members to co-sign the loan.


6. Refinancing

If you already have a loan and are just looking for a refinance, Kandell recommends that your first call be to your current mortgage holder. Since "your loan is already on the books," the bank has a stake in the refinance to be sure that you can continue paying the mortgage.

For people who already have an FHA or VA loan, you can streamline the refinance, which means you won't need an appraisal or a credit check as long as you made on-time payments for the past 12 months. If you have an FHA loan, you will need to pay the closing costs on the refinance out of pocket to avoid an appraisal. The only fee that you can roll into the loan without an appraisal is the FHA mortgage-insurance premium.


Final thoughts

The key is to not just take no for an answer. If the banks say no, contact an experienced independent broker who "creates relationships" with "old school" banks that sell the loans directly to Freddie Mac, Fannie Mae or Ginnie Mae, Kandell said. These banks don't set stricter standards than the government requires.

Tom Donahue finally got his credit score high enough to qualify for a loan and the couple got a 30-year, fixed-rate VA loan through Flagship Financial at 5 percent. With 12 months of on-time payments, they now will qualify for a streamline refinance to a lower rate, if rates are still lower.

Lita Epstein has written more than 25 books including "The 250 Questions Everyone Should Ask About Buying Foreclosures" and "The Complete idiot's Guide to Personal Bankruptcy."


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