What is a bad credit home loan?

A bad credit home loan is for borrowers that have had previous credit issues.  As outlined in the article on bad credit, the most common credit issues involve:

Since there is a greater risk to the lender with these types of loans, they have the potential to be more expensive in the long term as the lender attempts to offset the risk with a higher rate.  However, these loans are usually taken out over the short to medium-term with the intention to refinance to a more traditional lender at lower rates once your financial situation improves.

 

Why consider a bad credit home loan?

While it may appear that there are large downsides to a bad credit loan, there are many reasons they are a good solution for many people.  These can include the following.

  • Many bad credit loans will allow you to reduce your interest rate if you display excellent conduct once you have the loan.
  • This will also allow you to potentially refinance to a mainstream lender in the future at even lower rates once your credit file is clear.
  • Bad credit home loans still have most of the features of a regular home loan.
  • You may be stuck with your current lender due to previous credit impairment. This may make it hard to cash out funds or access your equity for personal reasons such as home repairs, important surgery and so on.  A bad credit lender may be willing to refinance your home loan, allow the cash out along with consolidating other high interest rate debt.
  • If you are purchasing your own home, you may begin to repair your credit file with a consistent address and you can remove yourself from the rental market.

 

Pro’s and Con’s of Bad Credit Loans

It is important to understand the benefit of a bad credit loan as well as the risks associated with them.

Advantages of bad credit home loans

  • Low requirements – once you have a bad credit file it can be next to impossible to get a home loan from a traditional lender. Bad credit lenders are much more flexible and will tend to have lower documentation requirements.
  • Range of options – there are a range of lenders that operate and specialise in this space. They have more of a willingness to listen to your story rather than assess you against a checklist, or worse still, use a computer algorithm to determine your suitability for a loan with them.
  • Less reliance on your credit file – many lenders in this space won’t even dig too deep into your credit file. While they want to know about defaults, arrears, and debt agreements, they are less concerned with your day-to-day conduct on many of your other credit facilities.
  • Can be refinanced – as you develop a good repayment history on the bad credit home loan, you will have the opportunity to request a lower rate or even refinance to another lender at a cheaper rate.
 

Disadvantages of bad credit home loans

  • Higher interest rates – lenders in this space will want to offset the increased risk by charging a higher interest rate.
  • Higher deposit – if purchasing you will need a higher deposit and if refinancing, they may want to you to own a home that has a low ratio of debt vs what the property is valued at. This is known as a low loan-to-value ratio (low LVR).  Both requirements ensure that if the worst-case scenario played out and the lender is forced to sell your home, they will easily recoup their funds.
  • Pay more overall – If you stayed on a bad credit loan indefinitely then you will certainly end up paying more overall. But as mentioned these loans are part of a multi-stage process where you renegotiate a lower rate after a period of perfect repayment, or you refinance away to another lender.
 

What Rate Will I Get?

There are a few factors that will determine the interest rate you obtain with a bad credit loan.

  • How old any defaults, debt agreements and judgements are (the older the better).
  • Whether or not these credit issues are paid, settled or unpaid at the time of application.
  • What type of credit defaults or judgments are listed and the reasons behind why they occurred. Generally, telco and utility-related defaults are less severe than financial default listings and it is easier to explain these away in a manner acceptable to the lender.
  • The loan-to-value ratio you have for the purchase or refinance. The lower the LVR, the lower the risk is to the lender, which will be reflected in a lower rate.

 

Conclusion

Bad credit home loans can be a great solution for you if you have a poor credit rating due to previous credit issues.  While they have some downsides, most notably the higher rate, they can provide you with a great interim solution so you can move forwards with your plans.

They should be seen as a temporary measure until your credit rating improves and you won’t have to wait for years to start achieving your goals.