For hopeful homeowners with severely damaged credit, there’s a long road to travel to become “bankable” once again.

Thankfully, time heals all – even credit catastrophes. Those in “credit rehab” may find their mortgage options to be limited in the early days (typically because they don’t have a big enough down payment for a lender to take a chance on them). But there is light at the end of the tunnel.

The post that follows examines non-prime mortgage tactics and other “B” lending issues. We talked with Fred Testa and Greg Domville. Both are well-known brokers specializing in alternative lending (a.k.a. non-prime or subprime lending). They were kind enough to answer every question we threw their way.

This discussion focuses on people who have reached the end of their line with credit. That means they’ve declared bankruptcy (BK) or filed a consumer proposal (CP). A consumer proposal is a deal with creditors to pay less than what you owe. For all intents and purposes, lenders treat folks with consumer proposals like bankrupt clients—at least from a credit risk standpoint.

Q&A on subprime lending…

What’s the maximum available loan-to-value (LTV) right after I discharge a bankruptcy or consumer proposal (BK/CP)? Domville says it can go as high as 75%, but it’s generally more like 65%. Expect a 1%+ lender fee, and sometimes additional broker fees. (Most non-prime mortgages are arranged by brokers, who sometimes don’t get compensated for their effort unless they charge a broker fee.)

Is it possible to get a mortgage before your BK/CP is discharged? Yes, says Domville, but it generally requires a private lender. Rates can be 8-9% or higher for a first mortgage, and 12%+ for a second mortgage. Private lender fees vary drastically but are 1.5% to 3.0% on average, he says.

Does the story matter? If a client has a good story behind his/her bad credit (e.g., catastrophic medical issues) there is not a huge difference in rate, says Testa. “It’ll maybe save them 1/4 point or so. What it does do is give the lender a comfort level to do the deal. The lender is still going to price to risk, however, and that is based more on the loan-to-value than anything else.”

What’s the best game plan for an applicant who was recently discharged from BK/CP and wants to buy? “I find the best scenario for a recently discharged client is to obtain an approval to 65% (from an institutional lender) and then top-up the required LTV with a private second mortgage,” says Domville. “This will generally yield a lower weighted average rate and payment than going all private on a first mortgage.” That said, the mortgage “must be well within the applicant’s budget,” he adds.

When is re-established credit required? Prime lenders—the ones with the best rates—want at least two years of re-established credit after a discharged BK/CP. (For more on that see here.) But Domville says, “Lenders granting approvals within the 2 years of discharge don’t generally have re-established credit criteria. Having said that, having some sort of re-established credit will permit a higher LTV and better rates.” Lenders also heavily weight derogatory credit and large debt loads if they occur after discharge. Note: Maxing out your credit cards after a bankruptcy looks almost as bad to a lender as missing a payment.

How important are home aesthetics to your lender? Marketability of a property is vital to non-prime lenders. Make sure the property looks decent for the appraiser. (All subprime approvals require an appraisal.) “Lenders consider pride of ownership,” says Domville, so ensure the dwelling is clean, carpets are vacuumed or shampooed, broken trim and holes in the wall are fixed, clutter is removed, landscaping is maintained, etc.

Will lenders know if you missed a mortgage payment? Most lenders still don’t report mortgages to the credit bureaus. However, “Many alternative lenders do condition for previous mortgage history,” he says. Missed payments after a BK/CP will result in a declined application or a dramatically reduced LTV and increased rate. If you find a lender willing to overlook a missed payment after discharge, expect the “best case” maximum LTV to be 75%, Domville says.

Can you refinance a past due mortgage? Yes, “but certainly only in the private sector, where 1st mortgage rates are 8%-plus on average,” states Domvile. “Maximum LTV is 65%. Exceptions occur with higher LTVs, but don’t bank on it.”

Non-prime Hits Prime Time…

The old days are the new days: “Brokering is going back to what it used to be,” says Testa. “In many ways, brokering in the late 80s and early 90s was the same as it is today. Amortizations were a maximum of 25 years and lenders would only go to 75% (loan to value), not 80%. Everything was being done with a first mortgage to 75% and if people wanted additional funds, they would need a second mortgage to 80% or 85%. We’re going back to the past. A lot of the young brokers haven’t been through those times.”

Coming Trends in subprime: Testa says we’ll see more and more MICs going mainstream. MICs will make a “big time” dent in the market because “they’re not federally regulated.” That makes them more flexible with lending guidelines.

2nds growing in popularity:  Testa is seeing “quite a bit more interest” in second mortgages now, even compared with a few years ago. But there’s only “a fraction” of the institutional lenders doing 2nds today, versus pre-credit crisis. MICs will increasingly be motivated to fill in the gap, he says. They’ll do 2nds to 80%, or even 85% LTV.

So are VTBs: Testa also sees a movement towards vendor takeback mortgages (VTBs). With institutional lenders tightening credit, “More people will find it harder to get financing, and motivated sellers will take back mortgages to move their properties,” he says.

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About the commentators: Fred Testa is a subprime expert with Mortgage Intelligence and a 38-year industry veteran. He was this year’s CMP Alternative Lending Broker of the Year.

Greg Domville is President of Plan B Mortgage Services. There he runs a centralized underwriting centre that focuses only on non-prime business for Dominion Lending Centres’ 2,000+ agents.

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Rob McLister, CMT