Income and employment are no substitute for good credit, and nonprime loans can help

Ross Harrison had been in the business world for 15 years running local newspapers in small communities. He had a solid income and employment history and thought he had his financial situation in order, including a substantial down payment, when he went to see a lender about getting his first home mortgage.

To his surprise, that lender and several more rejected his application. Why? Ross had no debt and no record of ever having it. Paying cash for everything, including clothing, cars, appliances and more, left him with no way to verify his willingness to repay debt - a major component of the mortgage application process.

Ross had believed that paying cash for large items indicated he was a responsible person who managed finances well and avoided interest fees. He expected this to be a positive factor in his mortgage application. In fact, the only positive aspect of how he managed his finances is that he had shown his ability to repay debt. To complicate matters, Ross was trying to buy in a "hot" market, where prices were somewhat higher than average.

To obtain a mortgage, the borrower needs to show both ability and willingness to repay a loan, especially as mortgage lending requirements are tightening. To do this, borrowers need to use credit, but they need to use it wisely. For example Ross could have taken out a loan to buy a car and then paid it off several months or even a year or two before it was due. While he may have had to pay some interest, he would have established an excellent credit record.

At the time Ross was looking for a mortgage several years ago, it was not common for lenders to use alternate forms of credit verification, such as utility bill payments. Currently many lenders would be willing to consider these as credit references in the mortgage application process. However, these are usually considered only if traditional credit verification is not available and other aspects of the application are acceptable.

Eventually Ross obtained financing for his home using a loan that carried a higher interest rate than he would have if he had established his credit worthiness.  However, this loan allowed him to refinance without any penalty after a year. This type of loan falls into the category of nonprime loans, which can be helpful to people in Ross's position as well as those with blemished credit positions. The loan allowed Ross to establish credit so that he could qualify for a lower rate.

After a year of on-time mortgage payments and working with credit counselors to develop a credit history, Ross was able to move up to a second home with no difficulty, receiving his loan approval in less than an hour. Ross never had "bad" credit, but having almost no credit had caused him almost as much frustration.

"My credit history didn't exactly inspire confidence," Ross said. "It wasn't all that bad; it was just nearly nonexistent, and I was asking for hundreds of thousands of dollars. I paid a price for a lender to take a risk on me, but now I own two homes with traditional mortgage products. This would not have happened without that risky first mortgage."