Refinancing a home loan for bad credit

Refinancing a home loan for bad credit

Managing your finances is never easy, but this can prove especially challenging if you’ve had problems with bad credit in the past. Whether you’re doing it tough due to financial problems from circumstances beyond your control, or if you’re trying to make up for money mistakes you’ve made in the past, a bad credit score can cast a long shadow over your future financial dealings, including refinancing a home loan.

But that doesn’t mean it’s impossible to refinance a home loan and ease your financial stress if you have bad credit. With a bad credit mortgage from a specialised lender, you may be able to get your finances back under control, and even refinance back onto a more typical mortgage further down the track.

How you can end up with bad credit

If you have any of the following in your credit history, banks and other lenders may be less confident about lending to you:

  • Defaults – on home loans, personal loans, or even credit cards and utility bills)
  • Outstanding debts – owing money on a car loan, personal loan or credit card
  • Declined loan applications – if one financial organisation decides not to risk lending to you, others may follow suit
  • Bankruptcy – stays on your credit history for 7 years

While some of these factors are more applicable to borrowers who are entering the property market (e.g. bankruptcy), any of these black marks that appear on your credit history after you’ve successfully taken out a home loan may affect your ability to refinance that mortgage further down the track.

How bad credit can affect your refinancing prospects

Refinancing a home loan essentially means swapping out your existing mortgage for an all-new one, with interest rates and features that better suit your finances. Even if you successfully applied for a home loan in the past doesn’t mean you’re automatically eligible for a new one, especially if you no longer have good credit. 

Most lenders reserve their best mortgages for borrowers they feel are most likely to pay back the loan and the interest. To a lender, an “ideal” borrower is one that can demonstrate both security (based on savings and/or equity), and non-risky behaviour (based on credit history). 

If your finances come up short in either of these areas, you may not satisfy the lending criteria for the mortgage offers with the lowest interest rates and the most flexible features. Even if you’ve built up enough equity in your existing loan to avoid paying Lender’s Mortgage Insurance (LMI) when refinancing, if you’ve previously defaulted on a repayment and gone into arrears, or you’ve taken on additional debts such as personal loans, you may be deemed too much of a financial risk to be offered a low-interest refinancing package.  

Can you refinance and get a better rate when you have bad credit?

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A significant percentage of people who refinance their mortgage do so in order to get a better deal on their property’s interest rate. But if your current home loan’s interest rates were established when you previously applied with good credit, you’re unlikely to qualify for a better one if your credit has since gotten worse.

Sometimes, it’s a better option to wait to refinance until you’ve had a chance to clear up some of your credit issues. Problems such as past defaults and bankruptcy can take up to 7 years to clear from your credit history, but it may be able to resolve some other credit issues in the shorter term. Paying off or reducing outstanding debt can often help, as can keeping a clean repayment record on your current loan.

How refinancing can help you manage your finances when you have bad credit

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If you’re looking into refinancing options because you’re struggling to afford your current mortgage repayments alongside credit card debts, personal loans and other expenses, then there may be refinancing options that can help you. These options may not necessarily lower your interest rate or shrink your mortgage repayments, but they could let you consolidate your other debts into your mortgage, so your home loan repayment is the ONLY one you need to manage. These bad credit loans for debt consolidation can be much simpler and more affordable in the short term than making separate repayments for each debt each month, each one at a different (and often high) interest rate.

To refinance to a bad credit loan for debt consolidation, you may wish to investigate the specialised non-bank lenders. Some of these lenders are specialists in nonstandard loans such as bad credit mortgages, and may be flexible enough to provide a refinancing package that suits your financial situation. The interest rates on these loans can often be on the higher side, but when you prepare your monthly budget, you may find you’re paying less per month than what you did when you were paying all of your debts separately.

Refinancing from a bad credit loan back to a standard loan

Because refinancing to a specialised bad credit home loan often means paying a higher-than-average interest rate, you probably don’t want to keep paying one of these loans for longer than you have to. Once you’ve been paying one of these loans for long enough to reduce your credit risk to lenders, you may want to refinance from your bad credit loan back onto a more typical mortgage.

To help establish yourself as a safer credit risk, it’s important to pay every instalment on your bad credit mortgage on time for at least 6 to 12 months. If you’re able to make additional payments onto the loan, that can help too. Also, try not to take out any new loans while you’re paying back a bad credit mortgage, and don’t let yourself fall back into debt – consolidating your credit card debt into your mortgage isn’t an excuse to max out your card again!  

Even when you’re coming off a bad credit loan, if you’re able to establish that you’re a relatively safe financial risk, then even a bank may be willing to help you refinance your mortgage onto a better interest rate and relieve a bit of that financial pressure. 

Compare refinancing offers, and seek professional advice

Remember that whether you have good credit or bad, refinancing a mortgage isn’t something to be taken lightly. Comparing the available options at RateCity can give you a better idea of what offers are available and which lenders are worth approaching, but it’s usually worth also consulting a professional financial adviser, who can give you help that takes your specific financial circumstances into account.

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Learn more about home loans

What is a bad credit home loan?

A bad credit home loan is a mortgage for people with a low credit score. Lenders regard bad credit borrowers as riskier than ‘vanilla’ borrowers, so they tend to charge higher interest rates for bad credit home loans.

If you want a bad credit home loan, you’re more likely to get approved by a small non-bank lender than by a big four bank or another mainstream lender.

How can I get a home loan with bad credit?

If you want to get a home loan with bad credit, you need to convince a lender that your problems are behind you and that you will, indeed, be able to repay a mortgage.

One step you might want to take is to visit a mortgage broker who specialises in bad credit home loans (also known as ‘non-conforming home loans’ or ‘sub-prime home loans’). An experienced broker will know which lenders to approach, and how to plead your case with each of them.

Two points to bear in mind are:

  • Many home loan lenders don’t provide bad credit mortgages
  • Each lender has its own policies, and therefore favours different things

If you’d prefer to directly approach the lender yourself, you’re more likely to find success with smaller non-bank lenders that specialise in bad credit home loans (as opposed to bigger banks that prefer ‘vanilla’ mortgages). That’s because these smaller lenders are more likely to treat you as a unique individual rather than judge you according to a one-size-fits-all policy.

Lenders try to minimise their risk, so if you want to get a home loan with bad credit, you need to do everything you can to convince lenders that you’re safer than your credit history might suggest. If possible, provide paperwork that shows:

  • You have a secure job
  • You have a steady income
  • You’ve been reducing your debts
  • You’ve been increasing your savings

Are bad credit home loans dangerous?

Bad credit home loans can be dangerous if the borrower signs up for a loan they’ll struggle to repay. This might occur if the borrower takes out a mortgage at the limit of their financial capacity, especially if they have some combination of a low income, an insecure job and poor savings habits.

Bad credit home loans can also be dangerous if the borrower buys a home in a stagnant or falling market – because if the home has to be sold, they might be left with ‘negative equity’ (where the home is worth less than the mortgage).

That said, bad credit home loans can work out well if the borrower is able to repay the mortgage – for example, if they borrow conservatively, have a decent income, a secure job and good savings habits. Another good sign is if the borrower buys a property in a market that is likely to rise over the long term.

What is a variable home loan?

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

How can I negotiate a better home loan rate?

Negotiating with your bank can seem like a daunting task but if you have been a loyal customer with plenty of equity built up then you hold more power than you think. It’s highly likely your current lender won’t want to let your business go without a fight so if you do your research and find out what other banks are offering new customers you might be able to negotiate a reduction in interest rate, or a reduction in fees with your existing lender.

What is an ombudsman?

An complaints officer – previously referred to as an ombudsman -looks at formal complaints from customers about their credit providers, and helps to find a fair and independent solution to these problems.

These services are handled by the Australian Financial Complaints Authority, a non-profit government organisation that addresses and resolves financial disputes between customers and financial service providers.

How much of the RBA rate cut do lenders pass on to borrowers?

When the Reserve Bank of Australia cuts its official cash rate, there is no guarantee lenders will then pass that cut on to lenders by way of lower interest rates. 

Sometimes lenders pass on the cut in full, sometimes they partially pass on the cut, sometimes they don’t at all. When they don’t, they often defend the decision by saying they need to balance the needs of their shareholders with the needs of their borrowers. 

As the attached graph shows, more recent cuts have seen less lenders passing on the full RBA interest rate cut; the average lender was more likely to pass on about two-thirds of the 25 basis points cut to its borrowers.  image002

How personalised is my rating?

Real Time Ratings produces instant scores for loan products and updates them based what you tell us about what you’re looking for in a loan. In that sense, we believe the ratings are as close as you get to personalised; the more you tell us, the more we customise to ratings to your needs. Some borrowers value flexibility, while others want the lowest cost loan. Your preferences will be reflected in the rating. 

We also take a shorter term, more realistic view of how long borrowers hold onto their loan, which gives you a better idea about the true borrowing costs. We take your loan details and calculate how much each of the relevent loans would cost you on average each month over the next five years. We assess the overall flexibility of each loan and give you an easy indication of which ones are likely to adjust to your needs over time. 

Do other comparison sites offer the same service?

Real Time RatingsTM is the only online system that ranks the home loan market based on your personal borrowing preferences. Until now, home loans have been rated based on outdated data. Our system is unique because it reacts to changes as soon as we update our database.

How does Real Time Ratings work?

Real Time RatingsTM looks at your individual home loan requirements and uses this information to rank every applicable home loan in our database out of five.

This score is based on two main factors – cost and flexibility.

Cost is calculated by looking at the interest rates and fees over the first five years of the loan.

Flexibility is based on whether a loan offers features such as an offset account, redraw facility and extra repayments.

Real Time RatingsTM also includes the following assumptions:

  • Costs are calculated on the current variable rate however they could change in the future.
  • Loans are assumed to be principal and interest
  • Fixed-rate loans with terms greater than five years are still assessed on a five-year basis, so 10-year fixed loans are assessed as being only five years’ long.
  • Break costs are not included.

Mortgage Calculator, Repayment Type

Will you pay off the amount you borrowed + interest or just the interest for a period?

What fees are there when buying a house?

Buying a home comes with ‘hidden fees’ that should be factored in when considering how much the total cost of your new home will be. These can include stamp duty, title registration costs, building inspection fees, loan establishment fee, lenders mortgage insurance (LMI), legal fees and bank valuation costs.

Tip: you can calculate your stamp duty costs as well as LMI in Rate City mortgage repayments calculator

Some of these fees can be taken out of the mix, such as LMI, if you have a big enough deposit or by asking your lender to waive establishment fees for your loan. Even so, fees can run into the thousands of dollars on top of the purchase price.

Keep this in mind when deciding if you are ready to make the move in to the property market.

What is the flexibility score?

Today’s home loans often try to lure borrowers with a range of flexible features, including offset accounts, redraw facilities, repayment frequency options, repayment holidays, split loan options and portability. Real Time Ratings™ weights each of these features based on popularity and gives loans a ‘flexibility score’ based on how much they cater to borrowers’ needs over time. The aim is to give a higher score to loans which give borrowers more features and options.

How can I avoid mortgage insurance?

Lenders mortgage insurance (LMI) can be avoided by having a substantial deposit saved up before you apply for a loan, usually around 20 per cent or more (or a LVR of 80 per cent or less). This amount needs to be considered genuine savings by your lender so it has to have been in your account for three months rather than a lump sum that has just been deposited.

Some lenders may even require a six months saving history so the best way to ensure you don’t end up paying LMI is to plan ahead for your home loan and save regularly.

Tip: You can use RateCity mortgage repayment calculator to calculate your LMI based on your borrowing profile