Qualifying for alternative lending with poor credit or high debt ratios

 

Securing a traditional mortgage from a major bank can be extremely difficult if you have a poor credit score or high debt ratios. However, this doesn't mean homeownership is completely out of reach. Alternative lendingAlternative lending options in Canada have opened up new avenues for borrowers who may not qualify for a prime mortgage.

 

What is Alternative Lending?

Alternative lending refers to any mortgage or real estate financing that comes from sources other than an "A" lender like one of the big banks. Common alternative lenders include private mortgage companies, credit unions, mortgage investment corporations (MICs), and private individuals.

 

These lenders take on higher risk borrowers and properties. In exchange, they charge higher interest rates and fees compared to prime mortgages. However, they have much more flexible qualification criteria around credit, income, and debt serviceability.

 

Qualifying with Poor Credit

Having a low credit score under 600 will make it virtually impossible to get approved by a major bank lender. Alternative lenders, on the other hand, will still consider you as long as you can reasonably explain any derogatory credit items.

 

Some examples of issues alternative lenders may work with include:

- Previous bankruptcy, consumer proposal, or debt settlement

- Outstanding collections or judgments

- High balance credit cards or unsecured debt

- Missed mortgage or loan payments

 

The lender will want to see that any credit issues were one-time events caused by circumstances like job loss, divorce, or medical issues - and that your financial situation has since been rehabilitated. Typically they want to see 12-24 months of re-established credit before lending.

 

What credit score do I need for alternative lending?

Each lender sets their own minimum credit score threshold, but generally alternative lenders will consider scores as low as 500-550 for well-qualified borrowers. The better your credit, income, and down payment, the better rates you can obtain.

 

Qualifying with High Debt Ratios

For prime mortgages, lenders use debt service ratios to ensure you don't take on too much housing debt relative to your income. The maximum total debt service ratio for a conventional mortgage is typically 42-44%.

 

Alternative lenders are able to qualify borrowers at much higher debt service ratios - as high as 50-55% in some cases. This makes them ideal for borrowers with good income but high existing debt obligations from things like:

 

- Car loans

- Student loans 

- Credit card balances

- Personal loans or lines of credit

 

How do alternative lenders calculate debt ratios?

Alternative lenders still use formulas similar to the total debt service ratio used by banks. However, they may make certain exceptions on debt calculations or have higher ratio ceilings based on the strength of the overall application.

 

Other Factors for Qualifying

In addition to rehabilitated credit and higher allowable debt ratios, alternative lenders have much more flexibility around other aspects that may be declined by an "A" lender:

 

- Self-employment or non-traditional income sources

- Recent arrival to Canada with limited domestic credit history

- Non-traditional downpayment sources like private loans or gifts

- Properties in need of repairs or renovations

 

As long as you can reasonably explain your situation and demonstrate willingness and ability to afford the mortgage payments, alternative lenders will consider your application.

 

Do I need a downpayment for alternative lending?

Many alternative lenders still require downpayments in line with standard mortgage rules (e.g. 20% for insurable mortgages, 35% for conventional mortgages). However, some may accept much lower downpayments, especially if the property is easily rentable or you have other net worth assets to secure the loan.

 

The Tradeoff - Higher Interest Rates and Costs

While more flexible than "A" lenders, alternative mortgages do come with higher interest rates as compensation for the increased lending risk. Depending on your credit situation, expect alternative mortgage rates to potentially be 2-4% higher than best prime bank rates.

 

You'll also pay higher lender fees and more expensive mortgage default insurance premiums. Some alternative lenders may also require borrowers to purchase additional insurance or investment products as part of the mortgage approval.

 

What is the average interest rate for alternative lending mortgages?

As of 2023, interest rates for good alternative lending mortgages in major cities like Toronto or Vancouver typically range between 5.5% to 9% for a low ratio 1-year fixed or variable rate mortgage. Rates will depend heavily on your credit, income, and down payment details.

 

In exchange for these higher costs, alternative mortgages can provide a path to homeownership and credit rebuilding. Once you make steady mortgage payments for 12-24 months and improve your credit, you can refinance to a prime mortgage and take advantage of lower rates.

 

If structured properly, alternative lendingalternative lending can provide a short-term solution to consolidate high interest debt, resolve credit issues, and establish yourself as a qualified mortgage borrower for the long-term.