Even though banks have tightened up their lending standards since the housing market crashed, it’s still possible to refinance your mortgage with a less than stellar credit history. Unfortunately, refinancing gets progressively more expensive the lower your credit score is — so you should only do so if the terms make it worthwhile. The general rule of thumb is to be able to reduce your rate by a full percentage point to make refinancing advantageous..
While refinancing a mortgage is tougher to accomplish when your credit is bad, you can nevertheless get it done. Here are five tips to help you help you through the process.
Shine Up Your Credit Report
If you have bad credit, the best way to qualify for a mortgage is by doing your best to improve it. Start by correcting errors on your credit reports. By law, you're permitted a free copy of your credit report each year from all of the three major credit reporting agencies (Experian, Equifax, and Transunion.) Once you have copies, check them for any errors regarding your payment history on the credit accounts listed. If you find one, you’ll need to contact the credit agency that produced the report, inform them of the error, and submit copies of your own payment records in order to back up your claim.
Next, you’ll want to show patterns of good credit. A few delinquencies on your report (and even a bankruptcy) can be explained — and they’re unlikely to ruin your chances for a refinance if they were due to temporary drops in income. Nevertheless, it’s important to re-establish your credit by having as many good lines of credit as possible. Make a habit of paying your bills on time and pay off as many high-balance credit cards as possible. If your balance exceeds 25% of the limit on any card, it's going to hurt your credit score.
Know Your Credit Score
Your credit score will be a major player in determining the interest rate lenders offer. It’s important to know what that score is before getting started.
A credit score of around 680 means that you'll pay about half a percent more than a borrower with a "perfect" score of 760 or more. A credit score of 620 equals a rate about 1.5 percentage points higher than a borrower with perfect credit. If your credit score is below 600, you’ll have a tough time refinancing. There may be a few lenders that will approve you, but you can expect to pay a rate considerably higher than other homeowners — meaning refinancing may not be worth it at all.
Get Rates from Multiple Lenders
The key to refinancing — whether you have bad credit or not — is to shop around. Different lenders cater to different parts of the market, some of them even specializing in loans for people with poor credit. Once you have your credit score, contact six to ten lenders and see what terms they offer. Include private lenders, banks, and mortgage brokers on your list. Remember, it doesn’t cost anything to shop around, but it might cost you not to.
Consider Government Insured Loans
The amount of equity you have in your home will also affect what kind of rate you’re offered. If you owe more on your home than it’s worth, it will be incredibly hard to find a lender who will work with you. Even if you only have a little bit of equity in your house, banks may be cautious since the new loan is based on the current market value of your property.
If you don’t have sufficient equity in your home, you may still be able to refinance through lenders offering government-backed loans.The Federal Housing Administration (FHA) has loan programs for people with poor credit — many including interest rates lower than that of conventional loans. In order to qualify, your overall credit history cannot consistently reflect late payments or delinquencies. If you have judgments or delinquent federal loans (such as tax liens and student loans), you may not qualify.
Make Your Application Attractive
Bad credit alone may not prevent you from getting a refi — but if the rest of your loan packet is iffy, a refinance may be off the table. Offset bad credit by making the rest of your mortgage application as immaculate as possible.
Gather all employment paperwork (W-2s, paystubs, etc.) in order to document your income. If you’ve been employed for a long period of time, stress this to the lender as it shows financial stability. It also helps to provide bank records that demonstrate proof of savings — these cash reserves make your overall loan application more attractive to a lender.
Bad credit can make refinancing difficult, but if you position yourself in the best possible light, shop for the best rates, and package your application properly, you’ll discover that you can get it done.