"Bad credit" home loans are more common than you may think. While it would be great if everyone had perfect credit histories, the reality is that life is messy and can often throw curveballs when you least expect it.

COVID-19 is a great example of a major disruption that placed enormous pressure on the credit position of many Australians. Other life events and setbacks that can adversely affect your financial standing include a relationship breakdown, a business failure, loss of employment and a chronic health condition.

Any blemishes in your credit history – for anything from an unpaid bill through to bankruptcy – can make it harder to get approved for a home loan.

It might seem hardly fair, but the good news is that you may still be eligible for what is sometimes known as a "bad credit" home loan – although the more apt description is a specialist home loan.

Specialist home loans – offered by a select few lenders in Australia – cater for anyone with an imperfect credit or repayment history. They're designed for otherwise responsible borrowers who've been thrown off-course by a serious life event, and are staffed by lending specialists who are trained to work with borrowers that need a little extra help to get their finances back on track.

These types of loans typically have a higher interest rate to reflect the higher perceived risk for lenders, but it's not something you'll have to worry about forever. Once you've shown you're reliable and capable of making repayments on time every month, you should be able to qualify for lower interest rates after as little as 12 months.

How do home loan lenders assess applicants?

Lenders have a responsibility to ensure that they only lend money to people who can afford to repay it. They look at a number of things to determine this, including income, savings, assets, how long you've been at your current residence and place of employment, and any debts or liabilities you may have.

They also look at your credit file, which holds information relating to your credit history for up to seven years. This includes any credit cards or loans you've taken out, and contracts you've had with service providers such as electricity and mobile phone.

Importantly, your credit file notes whether you have had any payment defaults, late payments (such as for bills or loans) and credit applications over that time. It will also note whether you've been declared bankrupt or had a Part 9 debt agreement in the last five years.

If you haven't checked your credit file recently (or ever), it's worth doing so to see what it says and to verify whether all of the information is accurate. It's not uncommon for people to discover a blemish on their account due to a long ago unpaid bill that's fallen through the cracks. Or worse – a default on your credit file that shouldn't be there (in which case, you can work with the credit reporting agency to correct your file at no cost to you).

Free credit reports are available from online sources by the dozen, but you're best off going straight to one of the main credit reporting agencies in Australia: Equifax, Experian or Illion (formerly known as Dun & Bradstreet). Each of these agencies tracks the same kinds of information, which means your credit file should look very similar across all of them.

Equifax is the main agency that mainstream lenders use to check a loan applicant's credit history, so this is a good one to look at when you apply for a home loan.

Do I need a "bad credit" home loan?

The automated credit decisioning implemented by most mainstream lenders means they'll typically reject applications automatically if they don't meet certain criteria. Having blemishes in your credit file – even for defaults that you've subsequently paid off – can be reason enough for most lenders to reject your application out of hand.

If your credit file contains any credit blemishes, there's a good chance mainstream lenders will deem you too risky to lend money to. In this case, your best remedy is reaching out to lenders like homeloans.com.au, which have systems and products in place to work with borrowers in your situation.

These specialist lenders are set up to assess borrowers on their individual merits, and rather than fixating on previous financial issues, they focus on your ability to pay off a home loan in the present.

The opinions expressed in this article are the opinions of the author(s) and not necessarily those of homeloans.com.au. The above is general commentary only and is not advice tailored to any individual's financial situation. We recommend seeking advice from a finance professional before implementing changes relating to your finances.