Finance: Escape a bad credit history

Are bad debts darkening your financial future? Now there's an alternative, says Stephen Pritchard

Consumer debt in the UK is at record levels, and rising rapidly. Collectively, Britons owe more than £1.2 trillion (£1,200bn) on mortgages, personal loans and credit cards. This is 20 per cent higher than in 2004.

At the same time, more individuals are facing court action to recover money when they cannot pay their debts. According to Registry Trust, the non-profit body that monitors county court judgements (CCJs), these rose last year by seven per cent, to 570,000.

CCJs stay on a person's credit history for six years, and a lender will take CCJs into account when deciding whether to grant a loan. In some cases, mortgage companies will not take on applicants with any CCJs against them. Some lenders will consider cases where judgements were a few years ago, or where the sums involved were small. Other lenders will agree a mortgage, but only at more expensive rates.

According to Louise Cuming, head of mortgages at Moneysupermarket.com, some banks and building societies will approach bad debt on a case-by-case basis. Some lenders are prepared to overlook CCJs, and even mortgage arrears, if they relate to a past relationship that is now over, or even past periods of unemployment.

In such cases, how the homebuyer has managed his or her borrowing since the problem is critical. "If, for example, someone had five CCJs and quite a few missed payments, but it was historic and there were matrimonial reasons for it, and they had paid their mortgage in an exemplary fashion for three years, they may well be prepared to lend on a prime [mainstream] mortgage rate," says Cuming.

The problem for home buyers with past credit problems is how to build up a solid track record of repayments if they are unable to obtain a mortgage or other credit. The conventional option is to borrow from a specialist "sub prime" or credit-impared lender, and then switch to a regular company after a few years.

Sub-prime lenders will take on home buyers who have had arrears, or even been repossessed, but for much higher interest rates - as much as 11.6 per cent, according to Moneysupermarket. Sub-prime lenders might also demand that the home buyer is tied to the loan for a number of years, even on a variable rate.

However, a handful of lenders are now offering an alternative, known as a "credit repair" mortgage. These mortgages work by allowing a home buyer to borrow at a premium, credit-impaired rate, but then switch to a standard rate without remortgaging after a blemish-free period of between one and three years.

Such deals are on offer from lenders including the Scarborough and Chelsea building societies and Accord, the specialist lending arm of Yorkshire Building Society. Accord requires borrowers to maintain repayments without problems for 12 months, while the other lenders look for three years of steady repayments.

Maintaining a healthy payment history is certainly worthwhile. Although some mainstream lenders will allow a few, small credit problems, such as an occasional missed payment or even a CCJ for a small sum, for borrowers who are forced to turn to the sub-prime market mortgages are significantly more expensive. The greater and more recent the debts, the more expensive the credit.

Accord, along with a number of other lenders that operate credit repair mortgages, offers stepped interest rates based on credit risk. Someone with small credit problems might be offered a loan, based on current rates, of 5.69 per cent. A borrower with a number of unsatisfied CCJs is likely to be asked to pay interest at the upper end of the scale, at 8.29 per cent.

After a year, however, borrowers can switch to any Yorkshire Building Society standard mortgage: the lender is currently offering a tracker mortgage at 4.45 per cent. Even if it costs a borrower more in the short term to repair their credit history - in the form of a higher mortgage rate - the long-term savings mean it can be worth it.