Investment tip: Can you invest in property with bad credit?

Experts always reiterate the importance of maintaining good serviceability, especially as it gets harder to acquire financing due to tighter lending regulations and unpredictable market movements.

In most cases, your credit file is considered the primary tool to assess your worthiness as a borrower.

What is bad credit?

In 2014, around 14 per cent of Australians have defaulted on a liability but most of them don’t realise that even the smallest mishap can contribute to having a ‘bad’ credit history, according to the Australian Retail Association.

Bad credit may include missed home loan repayments, unpaid bills or tax and excessive unsecured personal debts based on your current income and asset position. If you’re applying for a new loan with the same lender, your past credit history with them may also affect their assessment.

Defaults, bankruptcy, judgments, court writs and too many credit enquiries on your file as well as financial trouble, receivership or liquidation in your own company may also count as bad credit.

While being hit by financial hard knocks is something no one can foresee, the black marks will remain on your credit file records, even after you have successfully gotten back on your feet.

Banks and lenders can use your credit history against you when the time comes that you need to apply for a home loan, considering that they will have to shoulder a higher level of risk if they approve your application.

Most traditional lenders just resort to denying your application, taking the black marks on your credit file at face value without understanding the circumstance that led to a default, judgment or discharged bankrupt status.

As dire as it sounds, getting a home loan approved with a bad credit is not totally impossible — it’s only a matter of engaging a good mortgage broker and seeking the right lender.

Finding the right lender

Not all banks and lenders follow a strict code when it comes to approving home loans.

In fact, banks can change their lending policy “on a whim”, usually based on their level of risk at a certain point, mortgage broker Otto Dargan said.

Mr Dargan explained: “For example, your mate could have gotten approved six months ago but it doesn’t mean that you will get approved with the same bank as well.

Alternatively, your broker may suggest a non-conforming lender, who’ll ask you to provide details on the nature and amount of any defaults on your credit file as well as the reasons behind judgments and even bankruptcy,” he added.

Unlike traditional lenders, specialist lenders will take your personal circumstance into account when assessing your home loan application. Why did you have bad credit? Will a home loan get you in a better financial position?

Non-conforming or specialist lenders can let you borrow from 80 to 100 per cent of the property’s value even with paid defaults amounting to $3,000. Some of these “bad credit home loans” may require a specialist lender or a guarantor loan.

Your ability to borrow — from the principal amount to the interest you have to pay — will also be determined through your loan-to-value ratio (LVR). Certain exceptions may apply depending on your broker and lender.

“Providing evidence that you are paying your bills on time and the default or judgment was a one-off may be just enough to get your loan over the line,” according to the mortgage broker.

Bad credit home loans

Essentially, non-conforming or specialist lenders aim to give Australians a second chance at owning their home or growing their wealth after they have suffered a financial burden.

Some of the most common types of bad credit home loans are:

• Paid and unpaid defaults home loan - For borrowers who have defaults on their credit file.
• Discharged bankrupt home loan - For borrowers who are released from bankruptcy.
• Part 9 debt agreement - For borrowers who have completed a Part IX Agreement, or a previous debt agreement with their creditors or lenders.
• Tax debt home loan - For borrowers who have large debts with the Australian Taxation Office (ATO).
• Debt consolidation home loan - For borrowers who are unable to manage several small debts.

The interest rate that you will have to shoulder will be reflective of the risk that the lender will shoulder — the higher the risk of your loan, the higher the interest rate that will be charged to you.

Borrowing under 80 per cent of the property’s value will generally mean lower interest rate.

Experts strongly advised speaking to specialist mortgage brokers and credit experts to help you rebuild your reputation as a worthy borrower.

However, at the end of the day, Mr Dargan reminds investors that bad credit home loans are short- to medium-term fix to their financial problem and should not be incorporated into a long-term investment strategy.

Investors are advised to clear their credit history and refinance back to a prime lender with better interest rates in two to three years after setting up a bad credit home loan.

Moving forward, you must strive make your credit file look better by making repayments on time, paying off existing defaults, consolidating debts and avoiding any further bad credit listings altogether.

The information has been sourced from homeloanexperts.com.au and the Smart Property Investment website.