What are bad credit home loans?
Bad credit home loans are mortgages for people who have struggled to manage credit products in the past. Those credit products may include:
- Previous home loans
- Credit cards
- Car loans
- Personal loans
- Phone plans
- Internet plans
Bad credit home loans are harder to qualify for than ‘prime’ mortgages. They tend to have higher interest rates and may have higher fees as well.
Why? It’s because mortgage lenders regard people with bad credit histories as risky borrowers.
Of course, just because someone may have missed repayments or defaulted on loans in the past, it doesn’t automatically mean they will have credit problems in the future. Also, credit problems may have been caused not by excessive spending, but by sudden illness, job loss or divorce.
Bad credit home loans are designed to help people with bad credit to get the money they need to buy a new property or renovate an existing home.
Who offers bad credit home loans?
As a general rule, bad credit home loans are offered not by the bigger, better-known banks but by smaller, niche providers. These tend to be non-bank lenders (also known as ‘specialist lenders’).
There are more than 150 home loan lenders in Australia - and while all of them are happy to offer ‘prime’ mortgages, only a small minority are willing to provide bad credit mortgages.
Bigger lenders prefer ‘vanilla’ borrowers who conform to standard profiles. Why? It’s because they’re easier to manage.
Specialist lenders, by contrast, are more willing to treat borrowers on a case-by-case basis and to be more flexible in their lending decisions.
How do you take out bad credit home loans?
If you want to take out a bad credit home loan, you’ll need to visit a specialist lender to present your case, or get a mortgage broker to do it on your behalf.
To succeed, you’ll need to convince the lender that even though you’ve had credit problems in the past, you would be able to repay a mortgage in the future. That will involve explaining what caused those old credit problems and how those problems have been overcome.
Lenders will want to get an understanding of your financial position, so you should expect to be asked for documents like bank statements, credit card statements, employment agreements, payslips, tax returns and rental agreements.
As with all loan applications, you’ll find it easier to qualify for a bad credit home loan if you can present yourself as someone who has a steady job and good savings habits. With that in mind, here are seven possible obstacles you might face during the application process - and how you might be able to overcome these obstacles before you apply in the first place.
|Possible obstacles||Possible solutions|
|You’re carrying debt||Can you reduce or even pay off a loan?|
|You have credit cards||Can you cut up your credit cards? (If you have a credit card with a $5,000 limit, lenders will probably assume it’s carrying $5,000 of debt, even if you owe only $1,000.)|
|You’ve held your job for less than one year||Can you delay a job move you were thinking of making?|
|Your job is part-time or casual||Can you ask your company to change your status to full-time?|
|Your income is low||Can you ask for a raise or more hours or get a second job?|
|Your savings are low||Can you boost your bank balance by selling non-essential possessions?|
|You save a small percentage of your income||Can you boost your savings rate by eating out less, walking more and giving up booze?|
How can bad credit borrowers become prime borrowers?
Although you might need to take out a bad credit home loan today, there’s a chance you could eventually refinance to a prime mortgage if you improve your credit score in the meantime.
The key is to make sure that positive credit events are being added to your credit file - and that negative credit events aren’t. Here are some examples of both:
|Positive credit events||Negative credit events|
|Successfully applying for credit products||Unsuccessfully applying for credit products|
|Making scheduled loan repayments||Missing scheduled loan repayments|
|Paying off loans||Defaulting on loans|
By accumulating a catalogue of positive credit events, while simultaneously eliminating negative credit events from your life, you can improve your credit score.
Once you’ve achieved this, you might be able to move out of the ‘bad credit’ category. And once that happens, you might be able to refinance away from specialist lenders (with higher-rate home loans) to mainstream lenders (with lower-rate home loans).
This isn’t a quick or easy thing to do. Rather, building a good credit history requires a long-term focus on paying all your debts on time, every time.
How do you compare bad credit home loans?
Borrowers should look at four main factors when comparing bad credit home loans:
- Interest rates
Most lenders have rigid credit policies and reject borrowers who don’t fit. Flexible lenders, though, are more likely to treat people as individuals and to assess them on a case-by-case basis. These flexible lenders tend to be smaller non-bank lenders rather than bigger banks.
2. Interest rates
When comparing interest rates, take the time to look beyond the numbers. For example, some lenders might try to tempt you with what are known as ‘introductory’ or ‘honeymoon’ rates. These are interest rates that start at a relatively low level but then revert after a set period (say, 12 months) to a higher level. So what you see and what you get can turn out to be two different things.
Also, a fixed-rate mortgage with a higher interest rate might be more suitable than a variable-rate mortgage with a lower interest rate. Why? The reason is that the lender can change a variable interest rate whenever it likes - even the day after you sign up for the mortgage. If you’re lucky, the rate would go down; but if you’re unlucky, it would go up, and your repayments would increase.
But with a fixed-rate mortgage, the interest rate will stay the same throughout the fixed-rate period. That means your repayments will stay the same and your budget won’t receive any nasty surprises.
Pay close attention to fees, because a home loan with a lower interest rate and higher fees can prove more costly over the life of the mortgage than a home loan with a higher interest rate and lower fees.
The main fees to be aware of are upfront application fees and ongoing monthly/annual fees. You should also look out for the discharge fee, because if you plan to eventually switch from a bad credit loan to a prime loan, you will have to pay a discharge fee when you refinance.
You might find it easier to manage your bad credit home loan if they come with an offset account or redraw facility, because those features will allow you to get ahead on your repayments.
Another feature to consider - if it’s available - is a split rate option. This allows you to divide your mortgage in two: one half with a variable interest rate and one half with a fixed interest rate.
It’s important for all Australians to carefully research home loans - but it’s particularly important for bad credit borrowers, who are charged higher interest rates and have fewer options to choose from.
What are the pros and cons of bad credit home loans?
You should think carefully before applying for bad credit home loans, because although they can offer benefits, they can also have serious consequences.
Here are some potential negatives:
- If you’ve struggled to manage smaller loans in the past, taking out a big loan might be asking for trouble. If you fall behind on your repayments or even default on the loan, your credit score will get even worse.
- Your bad credit home loan application might be rejected. This would be likely to cause two problems: you’d forfeit your application fee and your credit score would further deteriorate (as a failed application is regarded as a negative credit event).
- If your application does get accepted, you’d probably be charged a higher interest rate and higher fees than prime borrowers. Also, you might be forced to pay lender’s mortgage insurance (LMI).
That said, bad credit home loans do have pros:
- You get to enjoy the thrill and pride that comes with owning your own home.
- You would no longer have to spend ‘dead money’ on rent.
- While you’d have to settle for a more expensive home loan, if you waited until your credit score was good enough for a prime mortgage, you might that property prices had increased by tens of thousands of dollars in the meantime.
- Pride of becoming a home owner
- No longer spend ‘dead money’ on rent
- Get in early, before prices rise
- Loans are inherently risky
- Your application might get rejected
- Higher rates, higher fees, LMI
What are some alternatives to bad credit home loans?
One alternative to bad credit home loans is guarantor loans.
A guarantor home loan is one in which a third party (usually a relative) makes a legal commitment to meet the mortgage repayments if, for whatever reason, the borrower fails to do so.
The catch is that the guarantor needs to have a good credit rating and the capacity to pay off the home loan. The guarantor also needs to provide security (such as the family home), so that if the guarantor also fails to meet the mortgage repayments, the bank can seize the security and get its money back.
With a legally binding guarantee in place, a bad credit borrower becomes less of a risk. As a result, banks are more willing to lend to that borrower, and at lower interest rates.
Another alternative to bad credit home loans is for the borrower to take steps to improve their credit score - although that could take several years. If/when that happened, the borrower could then qualify for a prime mortgage. Of course, this process is easier said than done.