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Last updated 8/28/2008

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Guide to adverse credit mortgages

Adverse credit mortgages, better known as 'sub prime' mortgages are loans given to individuals with a poor credit history.

Many people have experienced credit difficulties at one time or another. Estimates suggest one in the five people have been turned down for a mortgage in the UK as a result of payment arrears on loans, mortgages or credit cards..  

Small wonder, then, that industry statistics suggest around 10 per cent of UK homeowners with a mortgage have an adverse status. This has not been helped by the advent of the credit crunch which has made mortgages more expensive and lenders more choosy as to whom they are willing to lend to.

Few people check their credit record on a regular basis, so they don’t know that a missed mobile phone payment or mortgage payment has left a black mark on their credit record. Credit reference agencies even show how often you have applied for credit, even if your application was unsuccessful.

Some standard mortgage lenders are willing to lend to applicants with relatively minor debt problems, for example, a County Court Judgment for a small amount which you have since settled.

Because mortgage applicants with serious past credit problems are a bigger risk than borrowers with a clean credit record, sub prime mortgage loans are more expensive and offer less flexible terms.

Higher costs

If you have several unsatisfied County Court Judgments (CCJs) or a history of arrears on loan repayments, you may be required to put up a larger deposit and pay a higher rate of interest than for a standard mortgage. You are likely to be offered a sub prime because of the higher risk you pose to the lender.

Wrestling with debt

How people get into debt

Unexpected events such as unemployment, illness or a relationship breakdown are common triggers for people to get into debt.  Even wealthy people can have a poor credit history because they are disorganised, fail to pay bills or have overlooked paying off their student loan.

The credit crunch has also made it much more difficult to obtain a, mortgage, but even more so if you have a poor credit history. 

If debts become unmanageable, homeowners can use their mortgage to consolidate more expensive debt they hold elsewhere, such as credit cards, store cards and personal loans.

Mortgage interest rates have traditionally been lower compared to the rates on credit and store cards, and even some personal loans. So, it can make financial sense, in certain circumstances, for homeowners to cut costs by remortgaging or by borrowing an extra lump sum from their current lender, called a 'further advance.'

But if you  have missed a mortgage repayment or defaulted on other loans, your current lender may not be willing to lend to you.  So if you want to remortgage, an adverse credit mortgage may be your only option.

What are CCJs and IVAs?

CCJs

If an unpaid creditor decides to take legal action against you, this can result in a County Court Judgment (CCJ). If you pay the debt, you avoid a court hearing. If you don’t, the judge will automatically make a 'county court judgment’ against you.

This order is called a CCJ and will be for either the amount agreed between you and your creditor or, if you can’t agree, a payment set by the court. CCJs remain on your credit record for a period of time, even if you have settled the debt.

IVAs

Individual Voluntary Arrangements were established in the mid 1980s as a way for people or businesses in financial trouble to cut their debts, but avoid bankruptcy.

IVAs are a legal contract between lenders and a borrower to pay back 30-50 per cent of their debts through an agreed monthly repayment over five years.

Interest is frozen over the repayment period and as long as the debtor keeps up payments he or she is debt-free when the term is up. However, IVA holders have zero credit status and cannot apply for any credit during the term of the IVA.

To set up an IVA, 75 per cent of the creditors have to agree to the proposal put forward by the individual's IVA practitioner. The IVA company will look at your income and outgoings and calculate how much you can afford to pay each month. According to accountant PricewaterhouseCoopers, an IVA application is made every seven minutes.

However, in recent years, some banks have been rejecting the terms offered by IVA companies on the grounds that they were only being offered around 40p in the pound of what they were owed. If this happens the IVA route is effectively blocked.

Do you need an adverse credit mortgage

Check your credit status

Before you apply for a home loan, it may be worth checking the records held on you by credit reference agencies. You can order a report online, by telephone, or by post from the three main credit agencies:

Experian http://www.experian.co.uk/

Equifax  http://www.equifax.co.uk/ and

MycallCredit  http://www.mycallcredit.com/

A Statutory Credit Report costs £2 and is a good indication of your status, although all three agencies charge extra for more detailed information or if you want regular updates to monitor for early warning signs of credit fraud.

Mortgage lenders automatically check your credit history and whether you are on the electoral roll when you apply for a mortgage.

If there is any incorrect information on your file, like a debt listed as unpaid when you can prove that it has been paid, you can tell the credit agency to erase it or add an amendment explaining the reason for the debt.

Warning!

Importantly, don’t be tempted to apply for credit recklessly. Each time you apply for credit, it shows up on your record, as a ‘footprint’ and too many applications for credit within a short period will not look good.

If your credit record is poor, the next thing to do is find out how serious it is and amend any inaccuracies. Then shop around for the best deal through a mortgage adviser.

Minor debt? – lenders who may consider you

Since the start of the credit crunch, many lenders have withdrawn from the sub prime market. A good mortgage broker may be able to help you, although you will have to move fast as mortgages are being re-priced at very short notice..

How do I apply for an adverse credit mortgage?

It’s hard to find in-depth information on sub prime mortgages because you can only apply for such loans through an Independent Financial Adviser or a mortgage adviser.

An adviser can explain how serious your credit problems are and will know which mortgage lenders will consider your application.

A mortgage adviser can help you with mortgage paperwork and prevent you getting more black marks on your credit file by applying to mortgage lenders that will reject your application.

In some instances, you may be eligible for a self-certification loan you cannot prove your income or you have just become self employed.  An adviser can help you sift through the range of adverse credit self-cert mortgage loans. Your mortgage is probably the most expensive financial product you will ever buy, so it’s important you make the right choice.

A little extra help?

Many specialist lenders don’t deal directly with the public at all. So, it is difficult for  you to compare rates yourself.

Before you talk to a mortgage adviser, you could do some research, however. Magazines like What Mortgage, Your Mortgage and Mortgage Magazine all list the best value adverse credit mortgages at the back to give you an idea of the kind of interest rates and fees you may have to pay.

How do I find a mortgage adviser?

Visit  http://www.unbiased.co.uk/ to find an IFA specialising in sub prime mortgages.

Warning!

It’s important to find a mortgage adviser you trust and who can provide a professional, transparent service. Any extra costs or charges should be discussed upfront and in particular, your options when any introductory rate comes to an end.

The adverse credit sector has a reputation for attracting a small element of profiteering advisers who target desperate customers and overcharge them for an unprofessional and biased service.

But since mortgages became regulated by the FSA, the market has improved, although the FSA has highlighted mortgage advice as area where irresponsible lending, with insufficient credit checks, has been identified

Since November 2004, all advisers have been required to explain the reasons for mortgage recommendations, how much they charge in fees, any remuneration they receive from the lender, and the services they offer.

If you use an adviser whom you found online, make sure there is a head office address on its website and that the firm is authorised by the FSA. Go to http://www.fsa.gov.uk/ and click on the ‘Firm Check’ button on the side panel of the home page.

What to ask/tell your adviser

  • Do you offer mortgages and insurance from all mortgage lenders in the market or a limited selection? The greater the choice on offer, the better your chances of finding a competitive deal
  • Do you charge fees or commission?
  • If so, is it a flat fee or a percentage of the amount borrowed?- Paying a flat fee is usually far cheaper than paying a percentage of the mortgage loan i.e.a  2 per cen feet on £100,000 would cost you £2,000, compared to a typical flat fee of £200-400
  • Do I qualify for a standard mortgage even though I have a few missed loan repayments?
  • How long will it take to repair my credit record?
  • I don't want a loan that is any longer than necessary.

A lighter shade of pale?

Sub prime mortgages come in various shades. If your debt problems are minor, you will be regarded as ‘light adverse’ and you may be offered an interest rate which is not much higher than the best standard rates.

If you are ‘medium’ or ‘heavy’ adverse, the rate of interest charged could be double what a standard borrower would pay.

Is an adverse credit loan worth it?

An adverse credit mortgage can help you achieve two things:

Firstly, if you take out an adverse mortgage because you couldn't get a standard mortgage, you can stay in your home despite your credit difficulties.

Secondly, providing you keep up with repayments, these loans help you repair your credit status by proving you can stick to a credit arrangement, so mainstream lenders may consider you in the future.

Depending on the seriousness of your debts, some high street lenders may lend to you again after two years or so.

What was that name again?

Don’t worry if you have never heard of many of the adverse credit lenders mentioned by your mortgage adviser. Mainstream mortgage lenders, like Halifax, own companies offering specialist mortgages like buy-to-let and adverse credit.

Since the onset of the credit crunch there are now far fewer adverse credit mortgage loans on offer than before.

A good way to compare one deal against another is to use the Key Feature Illustration (KFI) for each mortgage you are offered.

Features to compare include interest rate, deposit size, length of mortgage term and the rate you 'revert to' after the initial deal has expired, plus any fees and extra charges you need to pay.

Fees and charges

Lenders require borrowers to pay higher fees and charges for adverse credit loans because of the extra work involved in vetting someone with a poor credit history.

You should try to avoid having fees rolled up with the mortgage as you will have to pay interest on this for the lifetime of the mortgage.. Application fees can cost thousands of pounds compared to typical arrangement fees of £500 for a standard mortgage.

Tie-ins

Watch out for loans with overhanging redemption penalties that lock you into the mortgage, even after the discounted deal has ended.

Mortgage deals with a low initial repayment may be tempting. But you can find yourself between a rock and a hard place if you lock yourself into a rate which increases by £300 a month after a year and the only way out is to pay a huge redemption penalty.

Be wary of mortgage advisers charging extortionate fees to arrange an expensive sub prime mortgage. You might be eligible for a standard or light adverse mortgage which might pay the broker less commission.

Always shop around before you commit to an adviser or a loan, no matter how desperate you are to sort out your finances.

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