Refinancing your mortgage can provide you with a lot of financial benefits. You can cash out on some of your home’s equity when you need a large sum of money, or you can take advantage of lower interest rates to save on your monthly payments. You might also be able to get rid of your private mortgage insurance if you have enough equity in your home.
But if your credit has taken a dive since you first bought your house, it may be difficult to refinance. After all, you’ll essentially be taking out a new home loan and will have to go through the entire mortgage application process with a lender. But you’re not left without any options, even if you have bad credit. Learn how to make sure refinancing is the right move for you, and how you can get approved for a new home loan no matter what your credit looks like.
Make Sure Refinancing Makes Financial Sense
Before applying to refinance your house, analyze the total cost of the transaction to ensure it’s the right move. Yes, you might save money on your monthly payments with a lower interest rate, but remember that you also have to pay closing costs and other fees to get a new loan — no matter what your credit score may be. Also consider that your newly refinanced loan usually extends the length of your loan back to 30 years, regardless of how long you have been paying down your current loan. Not only does that mean it will take longer to pay off your house, you’ll also be paying that interest for longer. If you’ve been paying on your home for 10 years, that’s a long time to add back onto your mortgage, especially while making additional interest payments. Before you refinance, make sure you consider all of the financial implications, not just your new monthly mortgage payment. Your lender can help you estimate what expenses you’re likely to incur so have an in-depth conversation before making a decision.
Getting Approved with Bad Credit
Credit scores and interest rates go hand in hand. As with all loans, a higher credit score results in lower interest rates, saving you money every month. This really adds up on mortgages because you’re paying the loan off for so long. And even if you don’t have the best credit in the world, you still might be able to get approved for a home loan.
Start off by shopping around for lenders. You’re under no obligation to use the same lender as your initial mortgage, and it’s good to compare several offers. Refinanced loans can be structured in any number of ways and some may work for you better than others. For example, you might want to roll closing costs into the loan rather than paying them in cash up front. Or if you plan on staying in your home for a long time, it may be worth paying an extra point at closing in order to get a better interest rate. Think about what your goals are in refinancing and talk to each lender about the different ways you can achieve them. A good lender can also help you prepare for getting approved with your current credit score. If you can, demonstrate that you have strong cash reserves by putting extra money in the bank. You’re more likely to be approved for a loan if you have money on hand that is accessible because it shows that you’ll be able to pay for your loan even if your monthly budget is tight at times.
Another helpful move is to strategically pay down some of your debt. Although each lender’s exact requirements vary, most like to see a debt to income ratio of less than 41%. That means the amount of recurring debt payments you make each month (like your new mortgage, your credit card minimums, and any personal loans), should only take up 41% of your monthly pre-tax income. For example, let’s say your monthly income amounts to $5,000 before taxes and health insurance are taken out, and you pay $2,000 a month on credit cards and a car loan. Divide 2,000 by 5,000 and you’ll get 0.4. Multiply that by 100 to find the percentage of your debt to income. In this case, it’s 40%, which is less than most lender’s required minimum. To strengthen your application, consider making a few extra payments to lower your debt amount even more. It may take a few months for those numbers to be reflected on your credit report, so ask your lender to perform a rapid rescore if you’re in a hurry.
If your bad credit is still holding you back from qualifying for a refinanced mortgage, you also have the option of adding a cosigner to the loan. This basically means that someone else with better credit can help get you approved without having to be an owner on the property title. They’ll be responsible for the loan until they’re removed, which can only be done through another refinance or selling the home. The catch with having a cosigner is that they are also financially responsible for paying the mortgage. So if for some reason you can’t make the payments, your cosigner’s credit will also suffer — even if the loan gets all the way to foreclosure. You definitely want a strong and trusting relationship with a cosigner and talk about what would happen in a worst case scenario. Would the cosigner help make payments or be ok with having their credit diminished? Have an honest conversation to make sure you’re both comfortable with every possible scenario.
Once you’re ready to apply, you’ll need to supply the lender with similar documentation as you did when you first applied for a mortgage. This could include pay stubs, tax returns, and bank statements so they can determine your ability to repay the loan. Another important part of the process if the home appraisal where a professional appraiser comes to your house and assesses its current value. You’ll need to have at least 20% of the home’s value paid off, whether through mortgage payments or equity earned. So if your outstanding loan is $150,000 and the appraised value of the home is $200,000, you have 25% equity in your home and the appraisal should be good to go.
Federal Refinancing Programs
If you can’t get approved to refinance your mortgage through a traditional lender, check to see if you qualify for one of these government-sponsored programs. These are specifically aimed to help people with lower credit scores get approved for a refinanced loan. Each one has different requirements on your loan type, so read carefully before proceeding. If you qualify, you might be able to take advantage of significant savings.
This program is especially designed to benefit homeowners whose mortgage is greater than the value of the home, so there are no restriction on the loan-to-value. However, you do have to meet some basic qualifications to take advantage of this program. First, your loan has to be owned by Fannie Mae or Freddie Mac and must have been delivered to one of those entities by June 1, 2009. FHA loans don’t qualify and you can’t have already refinanced using Making Home Affordable Refinance Program (Harp 2’s predecessor).
You can also refinance with an FHA loan, regardless of whether or not your current mortgage is an FHA loan. There are two options: a cash-out refinance and a streamline refinance. The cash-out loan allows homeowners with equity in their house to receive a lump sum of cash by increasing your principal mortgage amount (and, consequently, your monthly payments). A streamline refinance can help lower your interest rate and you sometimes can get approved without having an appraisal performed, so it’s a speedy process.
Improving Your Credit Score Before Refinancing
Whether your application to refinance was denied or you want to qualify for even lower interest rates, sometimes it’s worth taking the time to raise your credit score. Start by paying all of your monthly bills on time and in full. If you do that for long enough, you’ll start to see your credit score go up steadily. You can also increase your credit card limit — as long as you don’t spend extra, you can quickly bump up your score.
For people with a lot of negative items on their credit reports, a credit repair agency may be helpful in disputing those items and getting them removed altogether. Check out our reviews of the best credit repair companies.
Credit scores are often categorized in five different ranges from bad to excellent. If you can increase your score enough to boost yourself into the next category, you could automatically qualify for better rates. Don’t give up on your goal of refinancing your mortgage. There’s always room for improvement which means there’s always a way to get a better rate — even if it takes a bit of time.