Following the Covid-19 pandemic, we have seen an increase in the number of enquiries where clients have experienced some form of “adverse credit”. Step Change (UK Debt Advice service) reported an increase in people with arrears in utility bills and council tax following the pandemic as well as an increase in the use of unsecured lending.
In the years following the Covid-19 pandemic, we have seen further economic turmoil with soaring inflation and cost of living exacerbated by the war in Ukraine.
In this month’s article, we review the different types of adverse credit a client can experience and offer solutions for how they can make things right.
Missed payments – defaulted accounts
For a lender considering a mortgage for a client, they need to assess the risk of the client being able to repay the said mortgage. In terms of risk assessment, the greatest indicator for future occurrence is whether the occurrence has happened historically. Where a client has missed a payment on a mortgage, this is considered with high severity for the lender for these reasons. If the mortgage arrears are not bought up to date by the client, this can lead to their property being repossessed by the lender.
Missing a payment on a utility or phone bill may not be viewed with the same severity but will still have implications for the client when applying for a mortgage in terms of the choice of lenders. Where a client misses consecutive payments, the account will eventually go into “default” status and be recorded on the credit file as such. A default remains on the credit file for six years – a large number of defaulted accounts or defaults with large balances are viewed with greater severity by lenders than missed payments.
“Payday” loans / Short term lending
“Payday” loans were considerably more popular prior to Covid-19 but are still available. They offer quick and easy access to finance but at extremely high APRs. For lenders, usage of “payday” loans indicates a struggle to manage finances and therefore many lenders will ask for a period free of their usage before allowing a mortgage. Often when clients use “payday” loans, the accounts result in default as the high-interest payments become unmanageable.
Debt to income ratio
As well as assessing for adverse credit when clients apply for a mortgage, most lenders will also consider the utilization of unsecured lending on a credit file. Where a client has high levels of debt, it may cause concern for the lender going forward and they may decide not to lend due to the future concern of the client being able to pay both their existing debts and a new mortgage.
County Court Judgements (CCJs)
When an account goes into default or when money is owed to a creditor, they may apply for a CCJ against a client. The creditor can apply to the courts for a CCJ to be imposed on the client, which gives them one calendar month to pay the amount owed to the creditor. Failure to do so will result in the client having a judgement recorded against them and also gives the court powers to allow other belongings to be repossessed in order to reclaim the money owed. CCJs remain on the client’s credit report for 6 years. Many lenders on the market will stipulate that a period of time has passed since the CCJ began.
Debt Management Plans (DMPs)
This is an arrangement between the client and their creditor to pay off their debts. A small amount is agreed to be paid back each month and this arrangement is made either directly through the company or through a licensed company. Lenders who accept a debt management plan will generally request evidence of 12 months’ payments before they will consider a mortgage.
Individual Voluntary Agreement (IVA)
Like a debt management plan, an IVA is a formal but legally binding agreement between the client and their creditors to pay back their debts over a set period. It is agreed by the courts so is viewed with more severity than a debt management plan. The IVA will prevent the client from taking out new credit without permission and stipulates that the client must inform the creditor of any increases in income. Where the client arranges an IVA, their equity (property) is protected from repossession (which is not the case for bankruptcy orders). Lenders generally will require a 6-year discharge period following the end of the IVA.
Perhaps the most serious of all is adverse credit as there are wider implications other than applying for a mortgage. For example, it can impact an individual’s ability to gain employment, rent a property and result in their property being repossessed. It is a last resort for many and will result and allows for a period of one year for the client’s assets to be divided amongst their creditors. After one year, the client is discharged and lenders generally require 6 years before they will consider a mortgage.
Debt relief order
Debt relief orders are like bankruptcy orders. The debt is frozen for a year and completely written off if circumstances have not changed. However, they are only available where the level of debt is below £30,000 and the client has little in the way of disposable income or assets. Lenders generally approach these in the same way as bankruptcy.
What can you do to manage your credit file?
There are several things we can advise the client to do to manage their credit, which include:
- Time–credit files improve with time providing the client can maintain payments and avoid utilizing large amounts of unsecured debt. After six years, adverse credit will disappear from credit files.
- Adding a partner to the mortgage application who has a good credit score can make the case lower risk for a lender.
- Lower your risk by increasing your deposit or applying with a high, stable income.
- Provide an explanation as to why the adverse credit occurred and be transparent with this. Often lenders will consider isolated incidents where there is a plausible, life event behind them.
- Monitor your credit file through an agency such as CheckMyFile which provides an overview of all three agencies (Experian, TransUnion or Equifax).It is important in any case to speak to an experienced adviser. There are hundreds of lenders available all with different criteria on adverse credit. To ensure you access the lowest available rate, speak to an experienced adviser who has access to the whole of the market.
Tom Woodall MSc CeMAP DipFA (Independent Financial Adviser – Prosperity Wealth)
Tom has a master’s degree from the University of Nottingham and is an experienced adviser in the field of mortgages and protection. He has delivered “whole of market” advice to clients specialising in cases with complex income and difficult credit profiles. He has
consistently managed a large caseload of clients juggling the different challenges as they arise! Tom has experience of advising on a wide range of
transactions including residential, buy-to-let and commercial finance.