It can be difficult to calculate how much money you will be able to borrow when it comes to a mortgage loan.
When you add a bad credit score on top of that, it becomes even more confusing.
Today, I’ll be discussing bad credit mortgages, how they work and how you can easily calculate how much you can borrow.
What is a Bad Credit Mortgage?
It’s understandable to be overwhelmed when attempting to secure a mortgage loan for yourself since there’s so many technical terms which you may be confronted with.
Bad credit mortgages (also called sub-prime or adverse credit mortgages) are mortgage loans which are meant for individuals that have a bad credit history.
You will find that if you approach a lender who offers a traditional mortgage and you have a bad credit rating, you will most likely be turned down.
Thus, when you have a poor credit score, you have two options:
- Take some time out to improve your credit score and then apply for a traditional mortgage.
- Opt for a specialised lender that deals in sub-prime mortgages.
Missing debt repayments, having a County Court Judgment (CCJ) taken out against you, having gone bankrupt in the past or opting for debt solutions such as an Individual Voluntary Arrangement (IVA), Debt Relief Order (DRO) or a Debt Management Plan (DMP) are all actions that can result in your credit score going down.
A subprime mortgage is suitable for individuals with a bad credit history who are trying to fund their purchase for a home.
It’s also an option to consider for homeowners whose financial circumstances have deteriorated since they first took out their former mortgage loan.
A subprime mortgage works in the exact same way as any traditional mortgage would. You borrow a certain amount in order to fund the purchase of a property, the property is put as collateral and you pay back the lender in monthly instalments over the course of many years.
The interest rate when it comes to a subprime mortgage is typically much higher than that of a traditional mortgage. This is because you pose a higher risk to the lender due to your bad credit score. Thus, the lender compensates for this by charging you a higher interest rate.
Another thing to note with a bad credit mortgage in the UK is that you may also be required to put down a much larger initial deposit/down payment than you would with a traditional mortgage loan.
When it comes to traditional mortgages, the initial deposit is usually anywhere between 3% to 20%. When we look at subprime mortgages, the initial deposit can range from anywhere between 15% to 30%.
Take Out a Bad Credit Mortgage and Then Get a Remortgage
One great technique of minimising the amount of money you have to pay back is to take out a bad credit mortgage at first and then switch to another mortgage lender (remortgage) after some time.
Let’s go over how this would be possible:
You opt for a subprime mortgage because you have a bad credit score. This is why the only lender that is willing to give you a loan is a specialised bad credit lender.
However, once your mortgage application is approved and you start making regular payments towards your subprime mortgage every month, your credit score will slowly start to improve.
Be sure to always make your payments on time and in full. If you fail to make your payments or pay them late, not only will your credit history worsen even further but even your house may be repossessed.
Over the course of a few years (or even months), your credit score may reach a level where you are able to apply again and get a mortgage from a traditional mortgage lender.
This would mean swapping to a different contract with a traditional mortgage provider who would offer you much lower interest rates compared to your previous mortgage.
As a result, you would lower the amount of money you’ll have to pay back as interest for the rest of your repayment term.
It’s a very effective way of reducing the amount you’ll pay overall when it comes to your mortgage.
There are a few things which you must keep in mind, however.
Firstly, you’ll have to pay an early repayment/redemption fee to the subprime mortgage provider. Be sure to take this into account when you’re determining whether getting a remortgage would be worth it for you or not.
Secondly, the traditional mortgage provider you’ll be switching to may have additional charges and setup fees. Be sure to take these into account as well when you’re making your calculations.
Once you successfully transition to a traditional provider, your interest rates will be lower and the repayments on your mortgage will be much cheaper.
Make sure to always apply to a provider that is authorised and regulated by the Financial Conduct Authority and is registered in England, Northern Ireland or Wales.
How much Mortgage can I Take Out with Poor Credit History?
Most mortgage providers allow you to borrow 4 to 5 times your total income.
Some mortgage providers even allow you to borrow up to 6 times your salary but this may be difficult for you considering the fact that you have a bad credit score.
It’s a good idea to look up a mortgage calculator online which can help you determine how much you’ll be paying in interest and what your monthly payments will look like.
If you’re having trouble divising a payment plan for yourself, you can seek help from an independent debt charity such as StepChange.
Finding a mortgage calculator online isn’t too difficult but make sure to take into account the fact that your interest rates will be much higher than a traditional mortgage.
It’s important that you get your finances in order and ensure that you’ll be able to consistently make repayments on your mortgage each month because if you start to fail, your house may be repossessed and sold off.
A bad credit mortgage calculator can help you determine how much money you should have saved up depending on the amount you’re going to borrow.
The mortgage calculator can also help you determine how much extra money you will be paying as interest when it comes to your subprime mortgage.
It’s a good idea to have what some people call a “rainy day fund”. This refers to a certain cash amount that you have saved up in case any unexpected expense comes up.
Remember that you’re going to be making payments towards your mortgage for 20 to 30 years so it’s quite likely that an emergency or some form of unexpected expenditure may come up during this time.
It’s generally a good idea to have about three months worth of your mortgage payments saved up as your rainy day fund.
These will help you keep your mortgage payments in check while you spend the rest of your money on whatever the unexpected expense is.
Getting a mortgage with bad credit isn’t too difficult. However, your options do become limited and you might be subjected to higher rates of interest as well as a higher initial deposit.
As long as you practice financial discipline, you can definitely get approved for the mortgage and after a few years of punctual repayments, you might even be able to switch over to a traditional mortgage with a lower interest rate.