Can you get a home loan with bad credit?
It’s often still possible to get a home loan if you have bad credit. In fact, there are several specialist lenders and mortgage brokers in Australia who cater specifically for bad credit home loan borrowers.
Mansour Soltani , Home Loans Expert
“A lot of people think that because I'm a discharged bankrupt or I've had a default, or multiple defaults, I can't get a home loan. That's not the case. There are lenders out there that will give you money under all sorts of circumstances. They just charge more for the risk.”
Mansour Soltani , Home Loans Expert
How do bad credit home loans work?
Bad credit home loans are designed for people who aren’t eligible for a loan with mainstream lenders. That might be because they have experienced financial difficulty or have a bad credit score due to missed payments, defaults or having been declared bankrupt in the past.
Bad credit home loans can offer a valuable solution to borrowers with credit issues looking to buy a home. But there are drawbacks. Specifically, bad credit home loans can be considerably more expensive than standard loans, with higher than average interest rates and fees.
According to Mansour, the strategy is usually to start out with the bad credit home loan to buy the property initially, but to refinance the home loan to a lower rate as soon as the borrower’s situation has improved.
Here are the other main ways bad credit home loans differ to standard home loans:
- The application is generally ‘low doc’ meaning you won’t be subjected to the same strict criteria that mainstream lenders apply when assessing loan applications.
- There may be restrictions on how much you can borrow as a percentage of the value of the property you’re buying (known as your loan-to-value ratio or LVR).
- Some lenders are more selective about what kinds of properties and postcodes they will fund loans for (e.g. large acreage properties in certain rural areas may be off limits).
Most lenders charge an extra ‘risk fee’ on bad credit home loans to mitigate the risk of the borrower defaulting. This fee is a percentage of the loan amount (e.g. 1%) and can either be paid up-front or added to the loan. Some lenders charge a separate Lender Protection Fee (LPF) on loans with a high LVR.
Reasons you might need a bad credit home loan
Common reasons you may need to go with a bad credit home loan provider include:
- You have an average or below average credit score (e.g. lower than 660).
- You have a bankruptcy filing or are subject to debt arrangements
- You have made numerous applications for credit in the last 12 months
- You have unpaid bills, taxes and other debt payments (defaults)
- You are the director of a business that is struggling financially
Here are two bad credit home loan case studies based on Mansour’s recent mortgage broking clients.
Case study 1
Borrower with too many credit applications and late repayments
A client of mine was looking to buy a property with a $900,000 loan, but he had made more than 20 other credit requests (credit cards, business loans, personal loans) over the last three years...
Case study 2
Discharged bankrupt
Another client I worked with recently is a discharged bankrupt. He came to me two or three months ago looking for a construction loan.
Am I eligible for a bad credit home loan?
There are bad credit home loan options designed to cater for virtually every type of borrower, whether you're a first-home buyer, refinancer or investor.
As long as you meet the basic criteria (being over 18 and either an Australian citizen or permanent resident), your eligibility mainly comes down to your capacity to meet the loan repayments.
Bad credit mortgage lenders are still bound by Australia's responsible lending rules (National Consumer Credit Protection Act 2009) and will consider each application individually based on:
- Your income
- Your expenses
- Your other debts and assets
- The loan amount
- Your loan-to-value ratio
- The property you’re buying (the security for the loan)
One common exception is people who are currently bankrupt and generally do not qualify for a home loan as a result, even among bad credit mortgage providers.
Check your credit score and report
Not sure what your current credit score is? Check it now for free. Checking won’t impact your credit score or report.
How to apply for a bad credit home loan
Here are the main steps involved in applying for a bad credit home loan:
1. Check your credit score and report
Review your credit report as a first step. Sometimes a bad credit score is down to errors in your report that can be fixed.
You can also check when information was added to your credit report and, based on that, work out how soon it will be removed. This can influence whether you choose to apply for a home loan now, or wait. For example, some missed payments or defaults can remain on your credit file for up to two years, according to the OAIC.
You can request a free copy of your credit report from one of Australia's main credit bureaus (Experian, Equifax and illion) every three months.
2. Speak to lenders (or a mortgage broker)
Before submitting an application, it’s best to speak to several lenders to discuss your situation and options.
You can either do this by approaching lenders directly or through a broker. Doing this will ultimately give you a better chance of being approved while allowing you to compare the rates and loan features different lenders may offer you.
3. Make an application
Most bad credit home loan applications can be completed online and relatively quickly if you have the necessary information ready.
Exactly what supporting documentation you’ll need to submit with the application varies depending on the lender and your situation, but it can include:
- Australian passport or valid Australian permanent residency visa
- Recent bank and loan statements
- Proof of assets (e.g. share trading account statement)
For PAYG employees
- Recent payslips
- Letter of employment
For self-employed applicants
- Proof of ABN and GST registration
- Business bank statements
- Recent tax returns, notice of assessments and financial statements
- Declaration of financial position signed by your accountant
Some lenders offering low doc home loans will require the bare minimum documentation. If you can’t supply the information above, it may be best to discuss options with a mortgage broker.
4. Loan is approved subject to valuation
If the lender is happy with your application, it will grant conditional approval. The last step involves the lender ordering a valuation of the property you’re buying.
Because the property will be used as security for the loan, the lender will only give full approval if the valuation is high enough so that the LVR on the loan is lower than the maximum it allows.
Compare bad credit home loan features
1
Extra repayments
Most loans allow you to pay more than the minimum regular repayments so you can pay down the debt faster. Look for loans that allow unlimited extra repayments without fees.
2
Redraw facility
A redraw facility gives you the option to withdraw any extra repayments you made on the loan if you need to access cash. Ideally you want a redraw facility with no limits or fees.
3
100% offset account
A 100% offset account is a savings or transactions account linked to your mortgage. Your mortgage interest is calculated on your loan balance minus the amount in your linked savings account.
4
Interest-only option
Some bad credit home loans will give you the option to pay only the interest on the loan for a period of up to five years. The eligibility criteria on interest-only loans (e.g. maximum LVR) are usually stricter, with higher interest rates.
5
Debt consolidation
Debt consolidation means rolling some or all your other debts into your home loan. This could mean paying a lower interest rate on the likes of personal loan and credit card debt, plus the convenience of a single repayment. The drawback is potentially higher overall interest costs due to the longer loan term (up to 30 years on a mortgage).
6
Split loan option
You’ll generally have the option of either a variable or fixed rate on a bad credit home loan. But some loans also offer the option to split the loan between a fixed and variable portion (e.g. 50:50, 60:40; 70:30). This can offer a combination of certainty (fixed portion) plus more flexibility to make extra repayments (variable).
Should you apply for a bad credit home loan or improve your credit first?
This is where having an initial conversation with potential lenders or a mortgage broker is crucial. Doing that will give you an idea of how likely it is that you will be approved now, and if not, what or how long it will take to improve your credit score and overall situation so you are eligible in future.
If it’s a ‘no’ now, what will it take to get to ‘yes’?
Mansour Soltani , Home Loans Expert
"Sometimes having run through scenarios with various lenders for clients, I can see that their application is not going to work. That can be first-time buyers, investors or whatever. But I always tell them how long it will be before it is going to work and what that will take. Sometimes it's a case of waiting for an interest rate drop, an increase in income or something negative coming off your credit report. If you do get a ‘no’ from your broker or your bank, ask them 'what next?'"
Mansour Soltani , Home Loans Expert
Pros
- Offers an alternative when other lenders won’t approve your application.
- Allows you to get into the property market sooner.
- Repaying a bad credit home loan consistently could help you build your credit score.
Cons
- Higher interest rates compared to standard loans.
- Higher fees, particularly ‘risk fees’.
- If your application is rejected, that may further damage your credit score.
5 tips to help you get your bad credit home loan approved
1
Demonstrate your ability to save
Lenders will want to see a history of genuine savings. They will check that you’ve gradually saved at least 5-10% of the property’s value over time (excluding cash gifts). Consider putting your money into a high-interest savings account that you top up each month. That way, when the lender asks for your bank statements, it will clearly show your discipline of saving money.
2
Show ‘clean’ bank statements
Lenders will ask for three months of bank statements to assess your income and expenses. They will comb over your transaction history to look at your spending habits and how you manage your money. Lenders want to see 'good banking conduct', which means no arrears, overdraws or dishonours. Additionally, too much discretionary spending may raise some flags. Ideally, you should always have money in your transaction account at the end of each pay cycle or month.
3
Kept your current debts in ‘good standing’
This means staying on top of any loan repayments and paying your credit card balance in full each month. This shows the lender that you prioritise your loan obligations, making you less likely to default on a home loan in their perspective.
4
Consider a guarantor
A guarantor is a family member (usually a parent) who may be willing to offer some of their home equity as additional security for your loan. Having a guarantor reduces your risk as a borrower, meaning lenders may be more inclined to approve your home loan application. However, if there’s a default and the property sale doesn’t cover the remaining loan balance, the lender may seek the guarantee amount from the guarantor, according to ANZ.
5
Continue to improve your credit score
Continue paying your utility bills and debts on time. More importantly, paying off debts sooner rather than later could improve your credit score, according to Equifax. You could use a snowball method that involves paying off your smallest debts first, then moving on to the next smallest, and so on. Keep in mind that lenders will look at the diversity of your 'credit mix' which shows you can responsibly manage different types of debt.
