While many Canadians are content to rent, there’s certainly a large population of us out there that are striving towards one goal; owning a house. However, for those with bad credit, their prospects can seem grim. In fact, bad credit mortgages are also known as “high-risk” mortgages, because of the level of financial risk that both the borrower and lender are taking. So, let’s discuss the mortgage process for borrowers with bad credit, and how their low credit score might not necessarily be the end of their dreams.
Your credit score is a tool that you can use to gain access to a variety of financial credit products. However, if you have bad credit, it can hinder your ability to get approved and lead to high-interest rates. But what is considered as bad credit?
Credit scores range between 300 to 900 and depending on where you fall, your credit may be seen as good or bad.
When it comes to purchasing a home in Canada, credit scores are an important factor. But, the good news is that consumers who have less than excellent scores, still have options.
Private mortgage lenders can be a good option for bad credit consumers who want a short-term solution to purchasing a house. Typically, private or alternative lenders offer mortgages with terms that last between one and three years where the borrower only needs to pay interest.
While this option will likely be more expensive than a traditional mortgage, a private mortgage can act as the first step toward rebuilding credit for those who have been left out of the traditional banking system. Ideally, the borrower would take out a private mortgage and once their term ends be able to apply for a traditional mortgage at a more affordable rate.
You can also use a mortgage broker to help you find a mortgage lender who accepts bad credit. In fact, some private mortgage lenders are only accessible through a mortgage broker. However, keep in mind, that these mortgage brokers may charge fees, which can increase the cost of your loan. These fees may be charged as a loan origination fee by the mortgage broker you work with.
While every bad credit mortgage lender will have a different approval process for their mortgage loans, there are some common factors each lender will examine.
Credit scores are used by lenders to determine mortgage rates for potential borrowers. The higher a borrower’s credit, the better their chances are of securing a better mortgage rate with a prime or subprime lender.
Your credit report will also be used to see who you might owe money to and how you’ve used your credit products in the past (timely payments, missed/late payments, defaults, etc.). This will give them an idea of how trustworthy you’ll be with your mortgage in the future. While most bad credit lenders will look beyond your credit when assessing your application, it is often still considered.
Lenders want to be assured of a borrower’s ability to pay them back, this means their household income can often be just as important as their credit. So, when you apply, your employment history and financial records will be examined to determine the likelihood of you defaulting.
No matter how much money you have in your bank account currently, a rocky employment history might make a lender question your ability to hold down a job. The same idea goes for your income. If your income is “confirmable” through the Canada Revenue Agency’s notices of assessment, your chances of securing a better rate will improve. For “non-confirmable” incomes, frequently seen with self-employed and commission-based workers, lenders will need to calculate their average yearly income before making their decision.
The higher the down payment that a potential borrower is able to make on a property, the better. Typically, borrowers with good credit are considered lower risk, so down payments as low as 5% of a home’s value are accepted. However, borrowers with poor credit will likely require a down payment of at least 20%. On the bright side, if a borrower does manage to make a larger down payment, not only will they have more home equity and a shorter payment period, but they will likely also have access to better mortgage rates.
Since a mortgage is going to be one of the most expensive things a borrower can undertake, potential lenders are going to examine your other debts. If a high portion of a borrower’s income is already going to their other debts, it means they’ll have less money to pay for the mortgage. This can affect their ability to qualify. Generally, lenders want a debt-to-income ratio of 36% or lower, however, some lenders may accept ratios up to 43%. This means unpaid credit card bills, car loan payments, or any other high-interest debt can affect the borrower’s chances of getting a mortgage.
This factor is especially important for potential borrowers with bad credit who are working with subprime or private lenders. After the borrower in question finds a house, they must have it appraised and ranked in accordance with how valuable an asset it is. If the lender is skeptical of a borrower with bad credit, they’ll need to be assured that the property is worth the investment they’ll be making.
While it’s not going to be as easy or affordable for a consumer with bad credit to purchase a house as a consumer with good credit, it is still possible to get a mortgage. Here are a few steps you can take toward securing a high-risk mortgage.
If you have bad credit or have gone through a consumer proposal or bankruptcy, an unstable employment history will only add to a lender’s opinion that you’re a risky investment. For that reason, it’s best to find a stable source of income, especially if you one day hope to work with a prime lender.
If you cannot wait until you rebuild credit, you can consider going with a lender that deals with bad credit borrowers. These alternative mortgage lenders often have lower requirements but also charge higher rates and fees.
The higher your down payment, the less risk your lender will have to take. The reduced risk will increase the likelihood of being approved for a mortgage. A larger down payment also means your mortgage payment period will be shorter, or you could choose to make smaller payments, amortizing your high-risk mortgage over a longer period of time.
A higher down payment will also help you qualify with a subprime lender if you need to, but it’s also a sign that you’re improving your finances, showing that you’re less of a financial risk for any prime lenders you apply with in the future.
Take the time and make the effort to rebuild your damaged credit scores. In general, the higher your credit scores, the more likely you’ll be approved for a mortgage and the more likely you’ll gain access to affordable interest rates. You can improve your credit by being responsible with any credit products and financial commitments you still have. Here are a few ways to help improve your credit:
A cosigner is basically a guarantor who promises to take responsibility for the mortgage in the event you default on the mortgage. This greatly reduces your risk as a borrower. As a result, adding a cosigner to your mortgage application can help improve your chances of approval and help you gain access to lower interest rates.
If you’re currently struggling with bad credit and are interested in purchasing a home, working on building a solid financial base and good credit should be your top priority. Nonetheless, you can still get a mortgage with bad credit. While finding the right bad credit mortgage lender may seem like a difficult task, it doesn’t need to be. Loans Canada can help you compare and connect with a licensed lender who can meet your unique needs.
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
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Bryan is a graduate of Dawson College and Concordia University. He has been writing for Loans Canada for five years, covering all things related to personal finance, and aims to pursue the craft of professional writing for many years to come. In his spare time, he maintains a passion for editing, writing screenplays, staying fit, and travelling the world in search of the coolest sights our planet has to offer.
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