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decoding the mortgage market

More than one in eight adult Canadians will declare bankruptcy or negotiate a debt settlement - consumer proposal - with creditors. That's a lot of people with devastated credit.

The majority of those people will want a mortgage at some point, but they'll find their options are limited. Following the credit crisis, funding shrank for high-risk mortgages, causing more than a dozen subprime lenders to close their doors in Canada.

Nowadays, riskier home buyers with subprime (aka. non-prime) credit make up less than 5 per cent of borrowers. And with a shaky housing landscape and nervous regulators, lenders are more careful than ever.

For credit-challenged home buyers, getting the best mortgage isn't easy – it requires discipline and planning. If you've recently gone through a bankruptcy or consumer proposal, a deal with creditors to pay less than you owe, here's what you need to know:

The Waiting Game
Mainstream lenders won't even consider you until you've been discharged from bankruptcy or a consumer proposal for at least two years. With that, you'll need stable employment and fully provable income.

If you can't wait those two years, your options shrink considerably but you can still get a mortgage - sometimes just days after discharge. Instead of putting down only 5 per cent with a "prime" lender, however, you'll need an uninsured lender like Equitable Trust or Home Trust, and maybe even a private lender. Most of them require ex-bankrupts to put down at least 25 per cent.

If you're exceptionally anxious to buy and have a large down payment, some private lenders will even grant mortgage approvals without you being discharged, but you'll pay a tidy sum .

The Rate Premium
Lenders price mortgages based on risk. Someone wanting a mortgage soon after insolvency will pay a premium, in addition to lender/broker fees of 1-2 per cent or more.

"Non-prime rates would be in the mid 4's to high 5's," says Fred Testa, a 38-year industry veteran and alternative lending expert with Invis. "It depends on the stability of income, equity, property and the story behind the poor or bruised credit."

Non-prime rates can be at least ¼-point better if there's a reasonable explanation for your bad credit. For example, lenders have far more sympathy for a bankruptcy caused by a medical crisis, than one caused by a spendaholic who simply dodged his or her debts.

Rates and lender fees may also be lower if you show six-to-12 months of perfect repayment of your cell phone, utilities and/or rent.

Credit Purgatory
A bankruptcy or consumer proposal requires that you atone for your credit sins by earning back a lenders' trust. One way to do that is by re-establishing your credit.

"Re-established credit means having at least two credit accounts, each with a two-year track record," says Mr. Testa. "They can be major credit cards, instalment loans, a car payment, and so on." The key: You need at least a $1,000 to $2,000 credit limit on each account for lenders to take them seriously.

Getting a non-prime mortgage is one way to re-establish credit but the most popular way is with a secured credit card. These cards require a security deposit and offer almost guaranteed approval. Just be sure to pick a secured card provider that gives back your deposit after you prove creditworthiness. You can do that by paying on time for 12 to 24 months, always making more than the minimum payment and not spending over 60 per cent of the limit.

A few banks, like TD, offer secured cards with no annual fees, rebate rewards and interest on your security deposit. Other providers, like Capital One, will even consider a higher credit limit than your deposit. My advice: Pick the right card the first time because cancelling a credit card can hurt your credit score.

The Term: Shorter is Better
Mortgage advisers usually recommend a one- to two-year term for non-prime borrowers. That gives people enough time to recover from credit woes and helps them avoid paying high rates longer than necessary. Experienced mortgage brokers can then coach borrowers on how to rebuild their credit and refinance sooner with a low-cost conventional lender.

Approval Constraints
If you want a subprime mortgage, the following may boost your rate or fees…or disqualify you altogether:

· Unmarketable Property: Non-prime lenders want easy-to-sell properties in case you default and they have to foreclose. It's much tougher to get the best rates and terms when you live in a small or rural community, or have an unusual property.

· High loan-to-values: In general, the less money you put down, the higher your rate.

· High debt after insolvency: Racking up debt after a bankruptcy or consumer proposal is a waving red flag for lenders.

· Questionable employment: Income stability matters. If you just got hired three weeks ago or can't document all your income, that's a big strike against you.

· Lender type: If you need a private lender, prepare to pay rates that are 2-4 per cent greater than a regular subprime lender. Rates are even higher if you need a second mortgage.

· Recent insolvency: The longer it's been since you declared bankruptcy, the more options you have as a borrower.

· Repeat bankruptcies: "Double bankruptcies will dramatically raise your required down payment and interest rate," Mr. Testa says. It eliminates all prime lenders and most alternative lenders as options, leaving you with mostly high-cost private lenders.

· Missed payments: Even one late payment after insolvency can ruin your chances with lenders. "Don't allow anything to go into collections that reports to the credit bureaus," says Greg Domville, President of Plan B Mortgage Services. "That includes parking tickets, cell phone bills, gym memberships, etc." Missing a mortgage payment after bankruptcy is the worst sin of all and gets you immediately declined if a lender finds out.

There's No Rush
Owning a home involves greater responsibility and expense than renting. When recovering from a credit nightmare, reject the urgency to buy. Focus first on rebuilding your credit and stashing away an emergency fund.

There are exceptions, of course. One example where it makes sense to buy sooner is when you absolutely need to move, you have 25 per cent down and your new mortgage payments are affordable and comparable to your current rent.

Either way, your goal during credit rehab should be to get your credit score back to a satisfactory number (650 to 680+) and make yourself appealing to ordinary lenders. Doing that will save you thousands in interest.

Robert McListeris the editor of and a mortgage planner at Mortgage Architects. You can follow him on twitter at @CdnMortgageNews.

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