Applying for and qualifying for a mortgage can be a lengthy and complicated process, but if you have bad credit you may find yourself getting turned away by banks before you have a chance to prove yourself financially.

Bad credit can be a hurdle in the process of getting a mortgage and purchasing a home, but it doesn’t have to be the end of the story. Read on to find out how to get a mortgage with bad credit in Canada.

What is Bad Credit?

As you probably know, in Canada, every adult is assigned a credit score — a three-digit number between 300 and 900 that indicates a person’s history with using financial services responsibly and paying back debts on time. A perfect credit score is 900, but it’s quite unusual for a person to have a perfect score. The majority of Canadians sit in the 600 to 700 range (650 is considered the national average, as of early 2020.)

If 650 is average, what is bad credit? As you might guess, bad or poor credit is anything below 650. Or, more specifically, poor credit is credit in the range of 550 to 650. Get below 550, and your credit is considered very bad.

A bad credit score isn’t permanent — most people can expect their credit scores to fluctuate quite a bit over their lifetime, since a credit score usually decreases when you take out a loan, then increases over time as you pay off that loan. In general, though, poor credit makes it more difficult to take out loans and use other banking services in the first place, which can, in turn, make it harder to build your credit back up. Poor credit due to a previous bankruptcy or lack of credit history can affect your ability to purchase a home even if your current finances are in good shape.

So now you may be asking, “can I qualify for a mortgage with bad credit?”

In the majority of cases, the answer is yes. If you have no income, or if you have absolutely no equity in your home then, no, you won’t be able to qualify for a mortgage, bad credit or otherwise. However, as long as you are prepared to put down a relatively large down payment, there are plenty of alternative lenders who are willing to help you own your home.

What is a Bad Credit Mortgage?

If you’re in the position where you have bad credit and you’re looking for a mortgage, you may have heard the specific term “bad credit mortgage”. But there’s nothing particularly special about a bad credit mortgage — it’s simply a mortgage, lent to someone with bad credit (in this case, a credit score below 650).

Of course, there are certain considerations that have to be taken by a lender before lending to someone with bad credit.

Lending to someone with bad credit carries inherent risk because bad credit can signify that you’ve previously had trouble with making payments on time or paying off a debt in full. Lenders interpret this as an increased risk that they won’t recoup their principle costs on the investment.

Accordingly, mortgages for borrowers with bad credit tend to carry higher interest fees than prime mortgages. They also require that you put down a larger down payment upfront — where prime mortgage lenders may require a down payment of 5 to 10 percent of a home’s value, subprime or poor credit lenders usually ask for between 15 to 20 percent or as much as 25 percent.

A bigger down payment means more equity in the home, which in turn increases the lender’s chances of recouping their investment in the event of a default, as well as improving your ability to apply for things like refinancing, a second mortgage, or a home equity line of credit if the need should arise.

Who Can Lend a Bad Credit Mortgage?

In general, banks can’t lend bad credit mortgages due to strict federal regulations and stress-test requirements.

Credit unions and trust companies are not regulated at a federal level, and so can offer a little more flexibility. Another option is an alternative lender, such as a Mortgage Investment Corporation (MIC) or a private lender. Alternative lenders have to either be licensed or work through a licensed mortgage broker, but they are not required to use stress-tests or to adhere to the same federal regulations as banks.

How do You Get a Mortgage with Bad Credit?

Since your credit score isn’t going to get you anywhere with the lender, the most important thing to be mindful of when applying for a bad credit mortgage is equity. Equity is the existing value in your home that hasn’t been borrowed against. Most lenders will look for a Loan-to-Value Ratio (LTV) of at least 80 percent — that means that at least 20 percent of your home must be equity or value.

For example, if the appraised value of your home is $500,000, and you have a mortgage worth $400,000, then your home has an LTV of exactly 80 percent. Any further payments you make toward your mortgage turn into additional equity. If you pay down another $100,000, now you have $200,000 in equity, or 40 percent of the home’s value, meaning your LTV is now 60 percent.

Can You Refinance a Bad Credit Mortgage?

In a word, yes. In fact, refinancing your mortgage can be a smart option if you’re a few years into your bad credit mortgage and you’ve been meeting regular payments on time. As you pay back your mortgage, your credit score may start to improve, and you may even have improved your credit enough to qualify for a lower interest rate.

Refinancing can be expensive, but in some cases it can be a good way to secure a lower interest rate or lock into a fixed interest rate if market trends indicate a sustained rate increase. Your mortgage lender or advisor can help you determine what your refinancing options are, and whether refinancing will be beneficial in your situation.

How to Get a Second Mortgage with Bad Credit

As with a first mortgage with bad credit, to get a second mortgage with bad credit, the first thing you need to do is ensure that you have an LTV of 80 percent or less. A second mortgage can be used to refinance your original mortgage, as above, and it can also be used to consolidate different debts into a single monthly payment. Second mortgages are riskier than first mortgages since if you default on your payments, the original mortgage lender gets paid first in the event of foreclosure or power of sale. For this reason, a second mortgage with bad credit is a very risky scenario — expect higher interest rates, and shorter-term, smaller loans.

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