Thin Credit History? How to Apply for a Mortgage

Dear Dr. Don, 

We are looking at different types of mortgages to buy our first home. We found out that we do not qualify for a conventional loan because neither of us has three lines of credit on our credit reports. We are both one line of credit short.

It's been suggested that we take out a Federal Housing Administration 5/1 adjustable-rate mortgage. As the idea goes, after we've made payments for up to 24 months we should be able to refinance with a conventional loan.

We're told that if we take this approach, we will have exited the ARM before the loan rate rises in year six. Then, we should be able to get locked in with a 30-year fixed mortgage.

I'm wondering if you think this is true. If you could provide some guidance, it would be a lot of help.

Thank you, -- Mac Mortgage

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Dear Mac, I don't think that you've been lied to, as such. But you might want to get a second opinion from a loan officer before pursuing the FHA 5/1 ARM. This type of loan is easier to qualify for. But why not try an FHA fixed-rate loan first? If the issue is lack of income, you'd like to know that early on. Could it be that you are too ambitious with the house you're seeking?

Couples with insufficient credit histories often can get lenders to consider nontraditional payment histories, like rent payments, gym memberships, cellphone bills or other regular payments. That could help make conventional financing a more realistic option.

To head into your first mortgage closing while expecting to refinance a few years down the road means you'll also be hit with a second round of closing costs. FHA loans have two kinds of mortgage insurance premiums: One is paid at closing, while the other is due every month as part of the loan payment. An FHA streamlined refinancing may help you get a fixed-rate mortgage later, but you'll also pay the mortgage insurance premium upfront.

An FHA loan has advantages over a conventional mortgage. Credit standards aren't as tight when applying for an FHA loan, and it allows for a smaller down payment. Ask yourself some questions, if you haven't already. What kind of down payment do you plan for your home purchase? What kind of equity do you expect to have in the home by the time you'd refinance it? A conventional mortgage will require 20 percent equity or private mortgage insurance.

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