High-risk home loans pulled

UK lenders have taken fright at the US mortgage meltdown. Some have pulled out completely, while others have raised their rates. Higher-risk borrowers who need a big loan to secure their dream home or who have a chequered repayment record face uphill struggles to secure finance which, where they can find it, will now cost them more.

DB Mortgages, Infinity Mortgages and Unity were the first to act, pulling their loans completely and not yet launching new deals. Elsewhere, Mortgages PLC has increased rates by up to 1%, Northern Rock by 0.6% and Edeus by 0.5% to 1%.

Charcol's Ray Boulger believes this is just the tip of the iceberg. He said: "These are the first to announce, but we will see many more forced to follow. Worst hit will be borrowers with the poorest credit history, who will now face significant premiums if they want a mortgage."

High-risk or so-called sub-prime mortgages are designed for those with credit problems who would typically be unable to secure a regular mortgage deal. Reasons might include loan or credit card debts, county court judgments (CCJs), mortgages or rent arrears and even bankruptcy.

Until recently there was a neat divide between prime and sub-prime, with the latter charging much higher rates for taking on the extra risk. If something in your credit history, and it could be something very trivial, meant high-street lenders wouldn't consider advancing a mortgage, you could turn to those operating in the sub-prime market, but this inevitably lumbered applicants with a much higher sub-prime rate and dearer mortgage repayments.

Over the past few years, the sub-prime market has exploded, now accounting for some 10% of overall mortgage lending. Around 30 lenders, ranging from specialists such as GMAC and Platform through to household names such as Alliance & Leicester and Cheltenham & Gloucester, now offer an abundant range of deals.

This has been great news for many borrowers. Competition has lessened the penalty for having a bad credit record, especially for those with less serious debts, who have been able to secure much cheaper loans.

The key development has been the trend of lenders to segment borrowers. Northern Rock, for instance, places potential borrowers in one of five categories, from 'near-prime' for those with minor credit problems, through to 'light adverse', 'mid-adverse', 'heavy adverse' and finally 'unlimited'. Near-prime borrowers pay the lowest premium over standard rates, but find yourself in the latter categories and you pay a big penalty compared with a regular high-street mortgage.

Intense competition has pushed rates down across the board, but particularly for near-prime borrowers. James Cotton, a mortgage specialist at London & Country, highlighted three of the best deals currently on offer. For borrowers with less-serious debt problems, BM Solutions, part of HBOS, offers a near-prime rate of 6.39% fixed for two years - only marginally higher than for those with a good history - available for up to 75% loan to value and with a 899 arrangement fee.

It is, however, only available to people with combined CCJs of less than 500, none of which must be from the past six months.

For those with a more chequered credit history, GMAC offers a deal to those with combined CCJs of up to 6,000. However, this two-year fixed rate, offered on up to 85% LTV, charges 7.25%, with a fee of 799. For those with even bigger debts, Kensington offers 7.44% fixed for three years, available without any limits on CCJs or mortgage arrears.

All these deals operate on the same basis as a regular mortgage, with borrowers obliged to verify their income. For those without that ability, such as the self-employed or those with a patchy employment record, there is the option of self-certification. But lenders view self-certified borrowers as an even higher risk, and this option typically adds another 0.25% to 0.5% onto the interest rate.

That's the good news, then. The bad news is that many of the very best deals are disappearing fast. Rising interest rates and tumbling money markets are bad news for lenders, and they are passing this onto borrowers. For example, Mortgages Plc, part of City giant Merrill Lynch, recently announced it was increasing its rates across the board by at least 0.75%, with some higher-risk products going up by even more.

Meanwhile, Boulger warned that the gap between prime and sub-prime deals might be about to widen again after years of narrowing. "Some of the deals on offer were too competitive," he said. "The gap has narrowed to the point where I'm not sure the extra risk associated with sub-prime lending is reflected in the rates on offer."

Boulger also predicted a possible "shakeout" among less established lenders.

Regardless of what rates are on offer, Boulger urged potential borrowers to first ask whether a sub-prime mortgage is necessary at all. Sub-prime mortgages are always more expensive than mainstream mortgages because of the extra risk and hassle involved, and should only be a last resort. And in any case, he said, many lenders are more accommodating than they used to be, and those with minor debt problems can often now secure a mainstream deal.

If the first lender rejects your application, don't give up - some lenders are more accommodating than others for certain credit problems. For this reason, Boulger is wary of specialist sub-prime brokers: "They will always sell you a sub-prime mortgage, even though you might be able to get a mainstream mortgage elsewhere."

Clean up your act to get best offers

Try to clean up your record as much as possible. Pay off debts and reach an amicable understanding with your creditors. If you can't clear them, then reduce them regularly and responsibly, so you have a solid repayment history to prove your finances are under control.

Apply as normal. Many lenders will grant a mortgage on their usual terms, if you can explain how the black mark appeared on your record, and if it involved only small bad debts.

Stay with your existing lender. If you are moving or need to borrow more money, your lender may ignore other consumer debts provided you have a good mortgage repayment record.

Consult a mortgage broker. They can often point you in the direction of lenders which are sympathetic to your particular circumstances, without charging you a higher rate.

If you are still getting nowhere, try a sub-prime broker. But push to get the cheapest deal based on the lowest credit rating you can qualify for.

Alternatively, do your own homework by researching sub-prime deals on the internet.