What is Considered "Bad Credit" When applying for a home loan?

Joe & Guy Gardiner0

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You probably know that you should always pay your bills promptly, avoid maxing out your credit cards, and keep up-to-date on all your debts. But do you fully understand how your credit score is calculated? Can "bad credit" affect your chances of buying your dream home? 

Unfortunately, a huge number of people don't have a clue what their credit file looks like, let alone whether their credit score is up to par or not. Reports indicate that two-thirds of Australian adults don't know their credit score, with approximately 2.7 million too scared to check it. 

If you're among the clueless/scared cohort, it helps to understand what's considered bad credit when buying a home. This article focuses on the inescapable facts about your credit score and how having a bad score can negatively impact your ability to purchase a house. But, first things first:

What Is a Credit File?

There are three credit reporting bodies in Australia that hold your credit file – Experian, Equifax, and Illion. A credit file is a collection of data about your borrowing and repayment activity. It contains your personal information, your repayment history in granular detail, limits and balances, enquiries for credit and information, and if you're a director in a business.

On your credit file, there's a number between -200 and 1200 that compares you as a borrower/debtor to the rest of the Australian population. This number is referred to as your credit score. And it's one of the factors lenders consider when assessing your mortgage application. 

What Is a Good Credit Score?

A credit score is partly a rating on your percentage chances of missing or avoiding repayments. All lenders want you to repay the loan. Therefore, they consider that score very important when making a decision to lend to you. The following credit guide by Equifax can be used as a reference to get a general idea of what scores make the cut, however, each credit provider may vary slightly.

  • 800 – 850: Excellent. Easy loan approval.
  • 740 – 799: Very good. Your application has a high chance of being accepted by most lenders.
  • 670 – 739: Good. Your application has a good chance of being approved.
  • 580-669: Fair. Lenders evaluate other factors, such as your income.
  • 300 – 579: Poor. Interest rates are usually very high if your loan is approved.

Most Australian lenders have their own criteria for determining whether you qualify for a home loan. For instance, they may evaluate how long you've been in your current employment or self-employment. They will also look at your savings deposit or home equity. So, you cannot accurately assess whether your credit score alone will qualify you for a loan.

After your application has been assessed, there are three possible outcomes:

  1. Pass - Your home loan will be approved.
  2. Fail - Your application has been declined.
  3. Refer - The application cannot be rated accurately. The application is referred to a manager for manual assessment.

What Actions Affect Your Credit Score?

1. Unpaid defaults

If you pay less than the agreed amount or miss payments, the lender may send you a notice of default as a warning that your account is about to default. This does not affect your credit file. If you are not able to make the missed payments, your account defaults, and it is recorded in the credit file. This negatively impacts your credit score.

Paying off the defaults after they have been recorded will help your credit score by reducing the total amount owed. However, the information about the default will not be removed from the file.

This information stays in the credit file for five years, after which it is removed, whether the default is paid off or not.

2. Too many hits on your credit file

There are two types of credit inquiries, soft inquiries and hard inquiries. Soft inquiries occur when your credit report is checked but is not used to evaluate your creditworthiness. Soft checks are often for promotional and informational purposes.

Hard inquiries occur when lenders check your credit report in order to evaluate your creditworthiness as a borrower. Hard checks are used to decide whether to decline or accept your credit application. 

Each time there is a hard inquiry on your credit report, it is recorded in your credit file.  These inquiries stay in your file for a while and may affect your credit scores. The higher the number of hard inquiries, the lower the credit score. 

Most lenders will not accept home loan applications if there are too many hard inquiries over a short period of time. If you would like to avoid too many hits, YouBroker can help you by pre-assessing your application on the bank's lending and underwriting terms prior to formally accessing the bank's hard credit inquiry.

3. Your address history

Your address history may affect your credit score. But it may not be in the way that you think. Credit reference bureaus and other lenders compile your credit report using the personal information you provided, such as your date of birth, name, and address. These are among the few common denominators across all your credit accounts. They appear on your credit applications, your lender's files, and on the credit reference bureaus' files. 

That said, frequently changing addresses over a short period of time could indicate instability to lenders. It may indicate a number of issues, such as difficulty in paying rent. This may lead to the rejection of the home loan.

Additionally, your credit report may have mistakes stemming from issues with your address. If your address is incorrect or outdated, it could lead to inaccurate or incomplete information on your credit file. This can affect your score. In order to avoid these errors, ensure that there is consistency in the registered address across all your credit accounts.

4. Credit mix

Credit mix refers to the multiple types of accounts that form your credit report. Types of credit include car loans, mortgages, and credit cards. It forms about 10 percent of your credit score. A good mix contains both instalment and revolving accounts. 

Maintaining a good mix shows an ability to handle multiple types of accounts because a history of responsible repayments can be evidenced. Along with the elements discussed above, improving your mix improves your credit rating.

5. History

This forms 35 per cent of your credit score. It is simply a record of whether you have been paying your bills on time. A single late payment may not affect your payment history, but continuous late payments will significantly reduce your credit rating.

The biggest items that affect a credit score include:

  • Missed home loan payments: This is the big one. Any missed payments on your home loan really count against you at the major lenders. The more the number of missed payments you have had in the last six months then the harder it will be to get a home loan from a prime lender at a prime interest rate.
  • Keep payments up to date for 1-2 years: Lenders and banks will make sure you have not missed a payment in the last 6 months, and generally, it's a good idea to ensure you have your last 1-2 years of payment completely on track, with no missed or late payments.
  • Personal loan, car loan, credit card and store card history: While one or two late payments will be tolerated with a covering reason (like a change in direct debit accounts, an address, or the like), defaults or continued missed payments can add up to bad news on the credit score front.

Get a Copy of Your Credit File

Before you apply for a mortgage loan, it would help if you knew your credit score and other important information prospective lenders will be interested to know about you. All this information lies in your credit file. 

Obtaining your credit file beforehand can help you know where you stand and whether the odds of purchasing a home are in your favour.

At YouBroker, we help prospective Australian home buyers obtain copies of their credit files easily and quickly as part of the application process. We use this data to pre-check your application, which can give you confidence in approval. 

Sign up on our website to get a copy of your credit file, and set yourself up for a mortgage that gives you approval based on your credit profile, and credit history.

Can I still get a home loan?

YouBroker can help you find your best home loan faster, even if you have a credit history that has had a few bumps and bruises. Simply head to the Get Started section, and find:

  • What lenders can approve you even if you have had paid or unpaid defaults or a low score
  • If you will find a solution at a prime, near-prime, flex prime, or low document home loan lender (these are like the grades of credit available).
  • How much they can approve you for
  • What lenders can save you the most fees and charges (which can be high in alternative and near-prime credit situations)

Bad credit home loans

If you have a bad credit history, lenders will see this and if they choose to lend to you, you’ll be offered a loan with a higher interest rate.

Sometimes you’ll have to choose a lender that specialises in bad credit home loans. But, as your credit score improves over time, you can seek to refinance to a lower interest rate home loan. This could save you money on your loan repayments over your loan term, as you’ll be paying less interest. This could save you a lot over the life of the loan.

You also may be able to refinance once negative information on your credit file, such as overdue accounts, has been dropped. This varies been 2-7 years (typically 2-3) depending on what specifically you’re waiting for to be dropped from your file.

Bad credit loans usually have:

  • Higher interest rates. As you are seen as more of a risk, lenders supplement this with higher interest rates.
  • Lower loan-to-value ratio (LVR). This means you may be required to save for a deposit of more than 20% of the home loan’s value. With specialist lenders, you may be able to secure a bad credit mortgage with 90-95% LVR, however, with this, you’ll likely have to pay for lender’s mortgage insurance
  • Higher fees. It is more common for bad credit home loans to have upfront and ongoing mortgage fees.

What can I do to help my hopes of home loan approval if I have poor credit?

Check your credit report for inaccuracies

In Australia, you’re able to get a copy of your credit report once every three months. To do this, visit one of the three major credit reporting companies in Australia online and ask them for a copy of your credit report. Go through your report thoroughly and check for any information that is inaccurate. If you do find any, contact the credit reporting company and ask for it to be correct, which may require proof that it is incorrect.

Take steps to improve your credit score

With your acquired copy of your credit report, you’ll know what your credit score is and where you land on the approval scale we talked about earlier. You can then get to work to improve your position on this scale. Get rid of any ‘buy now, pay later’ services once you’ve made all of your repayments, as well as your gambling accounts. Make sure you make any repayments or bills on time. Paying off car loans or personal loans can make a substantial boost to your credit score. Whilst this may not seem achievable, we recommend making a weekly, bi-weekly budget and reducing any unnecessary spending. To see some way you can improve your net worth, check out our article here.

Demonstrate your saving ability

Lenders want to see a history of saving, so having a savings account that you contribute money into regularly can significantly improve your chances of approval. It can show that you’re disciplined and able to save money in your current financial position.

Make sure your documents are in order

Submitting a high-quality application shows care, thoroughness and that you’re not hasty. Lenders tend to favour this, as presents you as a borrower as less of a risk. This also means the lender does not have to chase you up for documents that are missing or incorrect which can delay your home loan and reduce your chances of success.

Speak with a mortgage broker

Speaking with a mortgage broker, such as YouBroker, can help you build a case that shows debt problems you’ve had in the past are dealt with and won’t be an issue when borrowing. Get started on your home loan process today and for any questions left unanswered, please contact us right here!

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