Refinancing your home loan when you have bad credit

Having a bad credit rating can make it more difficult to be approved for a loan when you refinance, but there are some specialist lenders who are willing to give you a loan. However, you'll need to make a conscious effort to improve your credit rating and take control of your debt. This may involve showing the lender that you have enough equity or savings to borrow less than 80% loan-to-value (LVR) ratio.

If you'd like to refinance to get a better interest rate, save money on interest or consolidate other personal debts, here are some steps to help you with the process.

Other lenders who can help

There are several lenders in Australia specialising in bad credit lending that could help you, including the following:

• Pepper Money
• State Custodians
• Fox Symes
• Red Rock Mortgages

How to refinance if you have bad credit

When you have a poor credit rating, you'll need to apply for what's known as a non-conforming loan. Your eligibility to refinance to a non-conforming loan is in part determined by your property's current loan-to-value ratio as lenders look at the existing equity you have. The more equity you have in your property (in other words, the more of your property that you own), the less of a risk the lender will see you.

Most lenders will require that you have a minimum of 20% equity in your property. This means your LVR is under 80%, which is the benchmark where lenders perceive you as less risky. Having equity of at least 20% will increase your chances of refinancing to a non-conforming lender.

Before you apply for a new loan, follow these five steps:

1. Get a copy of your credit file. Accessing your credit file will help you understand how you look from the lender's perspective. This will give you an idea of the things a lender will look at when considering you as a customer. You can see your current credit limits, number of credit cards that you have and any late payments that have been reported.
2. Take control of your debts. The next step is to be proactive about repaying any existing personal debts that you have. If you're having trouble meeting your credit card or utility payments, contact your provider to negotiate a new payment plan. Create a plan to pay off as many personal debts as you can, and importantly, close each facility as they're repaid, so you don't create new debts.
3. Visit a mortgage broker. A licensed mortgage broker can discuss your borrowing needs with you in detail and help you with the application process. They will be able to draw upon their panel of lenders to find one that's more likely to consider your application in a positive light, given your impaired credit status.
4. Speak to a specialist lender. Specialist lenders evaluate borrowers not on the number of defaults and the amounts of each of these defaults, but how long ago you made these mistakes. They recognise that you may have become credit impaired due to life events, such as divorce, illness or loss of a job, and they are willing to offer loans to help you own your home and pay off existing debts.
5. Aim to borrow less than 80% LVR. This avoids the need for lender’s mortgage insurance (LMI) and means you’re a lower risk to the lender, which boosts your chances of a loan approval. Try to show the lender that you have a plan to repay any other debts, too, so they can see you're on a pathway towards a better financial future.

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How to compare bad credit home loans

When deciding on the best non-conforming home loan to fit your specific lifestyle, there are certain factors that will help determine which loan is best for you.

• Interest rate. Bad credit home loans generally have a higher interest rate, which is why it's so important to compare home loans to ensure you're getting the best deal.
• Comparison rate. Always check the comparison rate because it represents the true cost of your home loan. Since you're already paying a higher interest rate, you don't want to pay higher fees.
• Fees. Another aspect to take into account is the amount of fees that you will have to pay. For instance, does your potential loan provider have any hidden fees or are they upfront about their extra charges? It's crucial for you to know this information so that you won't be surprised with any additional expenses.
• Repayments. When selecting the most appropriate lender, you must be well versed in the loan repayment schedule. This will allow you to be more organised and know exactly when all of your monthly payments are due.

Keep debt consolidation loans separate.

It's possible to refinance your home loan to consolidate bad debts such as credit cards or personal loans, so you're paying the same low interest rate on these debts as your home loan. To successfully manage this sort of bad credit refinance, you should split your refinance loan so that you make separate payments for your home loan and your personal debts. Otherwise, you'll be paying your credit cards and personal loans off over 20-30 years with your home loan, which will cost a lot more overall. For instance, if you have $20,000 worth of personal debts and a home loan of $350,000, refinance to a new loan with two split amounts: $350,000 and $20,000. You can then pay more off the $20,000 portion, so you pay it off as quickly as possible. Just make sure you choose a loan that allows extra repayments.

Don't choose features that will tempt you.

If you know you have trouble with managing finances, then features such as a line of credit, which allows you to withdraw up to the value of the equity in your home, may tempt you to spend more. Similarly, if the refinance loan you choose has a free redraw facility you may be tempted to withdraw the extra repayments.

Don't apply for multiple mortgages.

Every application for a loan will appear on your credit file, so during the refinance process, don't apply with multiple lenders. If you unsuccessfully apply for refinancing with multiple lenders, it will be viewed negatively by lenders you approach in the future. Take the time to research, seek the help of a mortgage broker and find the right loan for you before submitting your refinance application. Mortgage brokers are professionals who specialise in helping borrowers find mortgages. Their services are usually free because they receive a commission from the lender you choose. Borrowers in tough credit situations might find it easier to get finance with a broker's help.

How can I improve my chances of approval?

Here are some steps you can take to improve the likelihood of your application for refinancing being approved.

• Discharge your bankruptcy. Your chances of being approved for refinancing are vastly improved if you've been released from your bankruptcy status. This usually takes a minimum of three years (more information on reaching discharged bankruptcy status is available from the Australian Financial Security Authority). Generally speaking, the longer you've been discharged, the better your chances of being approved.
• Save a deposit. Having a deposit of 20% or more saved can be hugely beneficial when applying for a new home loan, and it can also help when refinancing an existing loan. Being able to provide evidence of financial stability and security can improve your borrowing capacity. A deposit of 20% or more may also mean that you can avoid paying lenders mortgage insurance (LMI).
• Demonstrate repayment history. A lender will be much more likely to offer you the financing you need if you can prove a history of making loan and debt repayments on time.
• Provide proof of employment history. If you can provide evidence of a long and steady history of employment, a lender is much more likely to view your refinancing application in a favourable light.
• Don't apply for too many loans. Serial loan application is looked upon negatively by lenders. Every application you make is included in your credit history, so be selective about the lenders you approach.

Refinancing your home loan after bankruptcy can help you get your finances back on track, but make sure to compare your options and seek professional help so that you end up with the best loan for your needs.