How the Recession Affects the Approval of Home Loans for People with Bad Credit

Home loans for people with bad credit are particularly hard to find during a recession. There are a number of factors that make all loan loans harder to locate when the economy is struggling. However, those with bad credit will suffer the most in a slow economy. While the national interest rate is lower and the government typically introduces programs to stimulate the housing market, these federal efforts do not overcome the challenges high risk borrowers face in a recession.

Less Loans on the Market

The first fact to face for a high risk borrower in a recession is there are simply less loans available. Banks and lenders need cash to make loans to consumers. During a recession, borrowers default on loans, meaning banks and lenders have less cash on hand. Further, financial institutions are often heavily invested in the stock market. They will lose money just like every household that has investments during a recession.

Because lenders have less cash on hand, they cannot provide as many loans in a slow economy. The result is that applicants are competing for the few loans a lender is making. When you are a high risk borrower, you will be competing with applicants who have much better credit scores than you have. In order to convince the bank to loan the money to you, you will have to offer them an incentive such as higher interest rates or collateral.

Risk Is Less Appealing

Lenders make risky loans when the economy is strong. Often, these risks pay off because borrowers are getting raises or businesses are gaining higher profits. They are able to pay off their risky loans. However, in a recession, those risky loans are the first ones to go into default. The sub-prime mortgages or jumbo loans go into default earlier and faster than the moderate-risk loans. The lenders start to reconsider their attitude toward risk.

With a bad credit score, you are a high risk borrower. Lenders will be afraid that you will default on your loan. You will likely need to secure the loan against an asset in order to receive the financing. You may also need to accept worse loan terms to assure the bank you will not try to refinance or prepay the loan in the future. In the end, regardless of these tactics, you will still pay more on your loan than a low risk borrower.

Home Prices Drop

The worst case scenario for a bad credit borrower is an upside down mortgage. This happens when you owe a huge balance on a mortgage that was evaluated when the economy was strong. Your home drops in value, and you end up owing more than the home than it is worth on the market at the time. This happens more to high risk borrowers because they have financed more of the purchase price of their home and done this at a higher interest rate.

When you go to sell your home and get a new mortgage, you will not have any equity to cash out from your upside-down mortgage. This means you will have a smaller down payment, making you even higher risk according to lenders.