Buying a home, the hard way

Got a bad credit record? A 'sub-prime' lender may be your only chance of a mortgage, says Dido Sandler
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The housing market may be looking healthier but that does not mean banks and building societies are falling over themselves to lend money to just anyone. Many thousands of people may be turned down for mortgages thanks to poor credit records.

These people will include existing mortgage borrowers who have got into arrears previously or who have been repossessed; also those who failed to pay credit card or other bills and ended up with county court judgments against them.

Many credit blots end up on the records of credit reference agencies that are consulted by lenders. According to Chris French, the chief executive of Kensington Mortgage Company, a specialist lender to individuals with poor credit records, one single missed payment on a personal loan will not normally cause any problems for a borrower, but two missed payments in succession, for example, could result in a rejection by a mainstream lender. One high- street lender is said to have rejected 50 per cent of applications in recent months.

A new "sub-prime" market has sprung up in the last two years, reflecting stricter credit scoring by the traditional lenders and to cater for these credit pariahs. None are "cheap", however. The lenders - including Kensington Mortgage Company, Preferred Mortgages, Future Mortgages, Southern Pacific and Transamerica - will typically charge 2 per cent or more above standard mortgage rates (so 10 per cent or so currently) and many push up interest rates another 2 per cent if customers get behind in their payments. Most of the new operators are US-owned - this market is already well-established, and arguably more competitive in the US.

As well as rates being high, some lenders have been criticised for the harsh penalties they hand out to borrowers who get behind or to those who want to pay off their mortgage early. On Friday the Office of Fair Trading called for an end to the "oppressive" charges levied on borrowers falling behind on their payments and "inappropriate" penalties for early settlements.

Ian Darby, the marketing director of mortgage broker John Charcol, says people with imperfect credit histories should be wary of even the most upright lenders of the sub-prime market. Some borrowers end up with these lenders' higher rates because their mortgage brokers are unaware of the better alternatives, he claims.

Specialist lending operations run by mainstream banks and building societies are more flexible in their lending terms, and charge borrowers their standard variable rates rather than loaded ones.

These include Bank of Scotland Centrebank, UCB Homeloans and The Mortgage Business. But some cases will still be unacceptable. With over three months' arrears, unsatisfied CCJs or undischarged bankruptcies, Mr Darby says individuals wanting a loan have no other option but to go to the sub-prime market.

He says three years' disciplined repayments with a reputable player like Kensington Mortgage Company will give borrowers access once more to cheaper, mainstream lenders. If you do go with a sub-prime lender, here are some tips:

Check the annual percentage rate (APR), not just the headline quoted rate. Some lenders quote an interest rate of 9.9 per cent, but are effectively charging 5 per cent higher.

Try to ascertain what fees brokers are earning. Up to 1 per cent or pounds 500 may be acceptable. But one lender, Southern Atlantic, offers hefty commissions of 3 per cent, while CMC is said to give brokers 10 per cent.

Does the interest rate go up by more than 2 per cent if you default on the loan? Does your lender put you into the higher interest bracket after only one month in arrears, or is the period more generous? Will the lender give a commitment it will accept payments on the first working day after weekends or bank holidays?

Check for unreasonable redemption penalties. Kensington charges a more reasonable rate of 3 per cent in the first three years.

How are the company's interest rates set? Kensington sets its rate at a fixed percentage above Libor - the London interbank rate of interest, rather than above a standard variable rate set by the company itself.

Watch out for non-refundable upfront fees. Mr Darby says in the past customers have been required to pay large upfront non-refundable fees and then not been granted mortgages.

Has the lender signed up to the Council of Mortgage Lenders (CML) Code of Practice? This should make for clearer presentation of the deal.

Dido Sandler works for 'Financial Adviser', a specialist publication.