Historically if an individual had bad credit it signified that buying and owning a house would be impossible. Lenders (particularly major banking institutions) were not willing to take a credit risk by securing financing to someone who was likely to default on the mortgage. In healthier economic times when home values were stable and inflated (the housing bubble) banks lessened their grip on loan criteria making it possible for people with less than perfect credit to qualify for mortgages. Albeit small ones and requiring a sizable down payment.
The current global economy and the state of economic adversity have lead to the traditional mainstay of equity being worth less than it has in previous years. Whereas leverage against a home or property was thought of as 100% guaranteed against the value of the home, the volatility in the real estate market in many places has led to unstable equity. In other words a latent economy might not see housing prices increase and given the collapse of the “housing bubble” home prices have slowly started to adjust themselves to authentic (not inflated) valuation levels. The cash out value of a foreclosure (should the loan move into a state of bankruptcy) is not certain. And with that shift fewer lenders are willing to take chances on providing mortgages for individuals who do not meet a strict criterion.
Where exactly does that leave someone looking to own a house? If you have excellent credit coupled with a sizable down payment, you will have no issues at all. Even if you are a first time home buyer with a short credit history. As long as your income versus asset and debt ratios are within the safe limits to reassure the lender, you can bet that most financial institutions will be vying for your business. It’s a nice reality for some individuals but for the growing number of people in the world faced with economic slowdown, job loss or job sharing, increased cost of living and other inflationary factors, it is becoming more common to find that individuals have a less than perfect credit profile.
What Is Bad Credit?
Quite simply a bad credit rating comes from an unreliable credit history comprised of late payments, missed payments or complete defaults on amounts owning to creditors. These actions do little to reinforce faith in the integrity of the borrower or account holder. Bad credit can be achieved on any monthly payment or account from paying for your internet or cable, cell phone or utility bills and of course previous history of bankruptcy.
Declaring bankruptcy is one of the hardest decisions anyone can make and it is a choice that is made under situations where there are no other options. The reason is that a bankruptcy report on a credit file essentially makes you ineligible for funds through most lenders. It disqualifies you from getting a car loan, consolidation or a mortgage with any major lender. A bankruptcy validates that at one time you did owe money which you refused (or were unable) to pay under the circumstances of the day. In most countries a bankruptcy report lasts about seven years after which time the individual can slowly start to rebuild their credit rating by demonstrating financial responsibility and regular payment patterns. During the period of bankruptcy in the past, it would have been impossible for an individual to qualify for a mortgage. They were without a doubt, ineligible.
What Is A Bad Credit Mortgage?
Given the proliferation of individuals with bad credit and demonstrable need, other financial institutions have entered the marketplace to provide lending products tailored for the high risk borrower. The economy cannot simply come grinding to a halt simply because people have bad credit. Houses are built and need to be bought to keep people employed in the very large housing sector, and thus where there is a will, there is a way and arguably a lender for every possible type of credit history.
Depending on the lender, a bad credit mortgage may take a number of different forms. One consistent factor is that it will require a more sizable down payment than the average major lender. For instance, if most chartered banks require 5% to 10% down payment for a borrower with a solid credit history an independent lender may require 15%-20% instead. Should the lender default on the mortgage and the home or property is placed into foreclosure, the down payment amount is the only safe guard against recovering a reasonable portion of the value of the loan. In the case of a forced property sale the down payment amount would help recoup the loan amount after realtor commission fees and other costs of administration which would minimize loss of investment income for the bank.
Splitting the Risk
Most small to medium sized lenders who offer bad credit mortgages do so by “splitting the risk” with a major financial institution. For instance, the chartered bank may have approved a 75% mortgage for the property given the amount of down payment provided by the borrower. The independent lender may offer to finance the second part (or a second mortgage) for the remaining 25% of the needed funds but at a much higher interest rate. The reason for the additional fee for borrowing is that in the event of a foreclosure the first lender (the chartered bank) would be entitled to 75% of the value back from the home or property. The other lender would be entitled to 25% return on investment however if market value was not achieved for the property or fees and administration costs increased with handling the property, the secondary lender may not see the full 25% return. To mediate the higher risk, the independent lender requires a higher premium.
A bad credit mortgage is a flexible option for people who are recovering not just from deliberate credit delinquency but those who were affected by adversity such as poor health or unemployment. The mortgage gives them the opportunity to start fresh with lessons learned and places them on the road to rebuilding a solid credit history and financial future as proud new home owners.
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