Refinancing Your Mortgage When You Have Bad Credit

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With interest rates rising, it may not seem like the best time to refinance — especially if you have bad credit. But in many parts of the country, home values have risen significantly in the past few years, which may make a refinance worthwhile even if you’ve got some credit challenges.

Refinancing can also be a useful tool to address some of the underlying credit issues you face. Refinancing your mortgage when you have bad credit could allow you to get cash to pay off credit card debt, improve your future credit scores and lower your total monthly expense.

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Here’s a guide on why you might want to refinance now with bad credit, and how you can do it.

Refinancing to pay off other debt

One of biggest reasons to refinance when home values are going up is to access some of the equity you have built since you bought your house. Equity is the difference between how much you owe on your mortgage and the current value of your home.

With a cash-out refinance, you get a new mortgage for a greater amount than your current loan, and receive the balance in cash. You can then use that money to settle other debt and start boosting your credit score.

  • You can pay off high-interest rate credit cards. Even if you end up with a higher rate on a new mortgage, the rates on credit cards if you have poor credit are likely much higher — in some cases, as high as 26.99%. And since credit card rates are variable, they can go up whenever the market changes. If you’re only able to make the minimum payments, it will take a very long time to pay them off.
  • You can pay off large installment loans. Sometimes sudden income or employment changes can make a recent short-term installment loan a bigger burden. An installment loan is any type of loan paid back within a set period of time, like car loans and student loans. That new minivan payment may have been affordable when you were getting large bonuses at your job, but if that extra income suddenly stops, the $700 a month payment may create a strain on your monthly budget. A cash-out refinance can be used to pay off this debt, too — not just credit card debt.
  • Your balance can improve your future credit scores. A big part of your credit score is driven by how high your credit card balances are compared with the maximum you can charge, a number called your credit utilization ratio. If your credit cards are maxed out, your scores are likely to be lower. If you pay your balances down, and keep the balances low in the future, your credit scores may improve significantly.

It’s important to look at your short-term and long-term goals when considering a cash-out refinance to pay off debt when you have bad credit. You are replacing short-term debt with a long-term obligation, and starting over the clock on your mortgage. On the flip side, mortgage, student loan or car loan balances have less of a negative impact on your scores than high balances on credit cards.

There may be ways to minimize the amount of cash you take out. Try to budget to pay down or pay off credit card balances. Think about trading in a car with a high payment for something smaller or older to reduce the monthly payment.

Other reasons to refinance with bad credit

Although debt consolidation can provide a financial benefit, there are other objectives that can be accomplished with a refinance when you have bad credit.

  • Replenishing cash reserves. Cash can be taken out to create a cushion for an expected future purchase or expense, rather than using credit cards that are likely to have very high rates and payments.
  • Moving away from an adjustable or interest-only mortgage. If you currently have an adjustable rate or an interest-only payment period, you may have received notice that your payment is about to go up substantially. Refinancing to a fixed rate can give you security against large monthly payment increases in the future.
  • Renovating or upgrading your house. With bad credit, it’s much harder to get a home equity line of credit or a home equity loan. A cash-out refinance could help you do those upgrades to increase the value of your house, or take care of much needed repairs like a roof replacement or new air conditioner.

Credit union personal loans

Another source for personal loans is credit unions. In general, the rates at credit unions tend to be lower than those at traditional banks. Loan terms are often more flexible and borrower requirements less stringent.

Furthermore, consumers typically receive a more personal experience. Considering all these factors, many consumers choose to take out personal loans at credit unions over traditional banks.

  • Average rates: The APR at credit unions currently ranges from 6.49% to 18.00%. As of September 2018, the average rate at credit unions for a 36-month personal loan is 9.33%.
  • Term length: Depending on the lender, borrowers can choose terms from 12 months to 84 months.
  • Borrowing limits: Loan amounts vary among credit unions with some allowing up to $25,000 while others permit up to $50,000.

Programs available for refinancing with bad credit

Government loan programs such as FHA, VA and USDA loans will provide you with the most flexibility for refinancing if you have credit issues. Besides allowing you to get more cash out than conventional loans, they also allow for higher debt-to-income ratios, which means you can borrow more than you would be able to with a conventional mortgage.

Be prepared to provide extra documentation to offset your credit challenges. Write down a detailed explanation about what caused late payments, collections or charge offs and how things have improved, or will improve with the refinance.

  • Conventional cash-out refinance: Conventional mortgage programs will allow you to borrow up to 80% of the value of your house and have few restrictions of what you use the cash out for. If your scores are under 680, it may be difficult to get approved up to the maximum.
  • FHA cash-out refinance: The HUD-insured FHA mortgage is a government loan program that allows you to access up to 85% of the value of your home with few limits on how you use the money. FHA loans offer more flexibility for lower credit scores and credit issues, and allow for higher debt-to-income ratios than conventional loans.
  • VA cash-out refinance: Qualified military veterans can borrow up to 100% of the value of their home, and there are few restrictions on the use of the money. VA loans offer more allowances for credit issues, and can be approved for even higher debt-to-income ratios than FHA loans.
  • USDA cash-out refinance: The USDA loan program does allow borrowing up to 100% of the value of the house, but only for repair or remodeling of the home. Since the funds have to be provided to a contractor, this is considered more of a construction loan than a cash-out refinance. All of the money must be paid to contractors for the repair or construction work that is done.
  • FHA streamline refinance with and without an appraisal: After you have made six payments on time with your current FHA mortgage, you are eligible for a streamline refinance. The biggest advantage of this program is it doesn’t require proof of income, and if you are willing to pay some closing costs, you won’t need an appraisal either. The FHA streamline also doesn’t require a full credit report, just proof that your current mortgage has been paid on time the past six months. If you need to roll in costs, then you’ll need to get an appraisal.
  • VA interest rate reduction loan: Similar to the FHA program, this loan allows qualified veterans to refinance their current VA loans without verifying income and does not require an appraisal in most cases.
  • USDA streamlined assist: Allows for a refinance of the current USDA mortgage without full documentation of income, and without a new appraisal. You must save at least $50/month, and the last 12 months of mortgage payments must have been made on time.

What credit scores do lenders need to refinance a mortgage?

The credit scores needed to refinance a mortgage are not much different from what is needed to buy a house. Beyond the credit scores, lenders are still going to look at how you’ve managed your payment history on your credit report the past 24 months.

Your mortgage payment history will carry the most weight in the approval decision-making, followed by credit cards and installment loans. For example, you may have had some late payments on your credit cards, but if your recent mortgage payment history is perfect, the lender may still approve your loan.

The consequence of bad credit is a higher cost of credit. Below is a loan level price adjustment chart that is used by one of the largest sources of mortgages in the U.S., Fannie Mae, based on an LTV range of 75-80%.

Credit ScoreIncrease to the cost of your interest rate

More than 740

0.50%

700-719

1.25%

680-700

1.75%

660-679

2.75%

640-659

3.00%

Using the grid above, someone pursuing a $250,000 maximum cash-out refinance with a credit score between 640-659 is going to pay $3,125 more than someone who has a score between 680-699 if they are borrowing the maximum 80% cash out on a conventional mortgage refinance.

Below are the minimum scores for refinancing based on the different loan programs available.

  • Conventional: 620 is the standard minimum for Fannie Mae and Freddie Mac conventional mortgage loans.
  • FHA: FHA loans will require a 580 FICO score for most refinance loans. Exceptions can be made for scores as low as 500, but will require a higher amount of equity.
  • VA: Most lenders will require a 580 FICO score, although like FHA, exceptions can be made depending on the equity level.
  • USDA: Most lenders will require a 640 score, although exceptions can be made down to 580.

Shopping around for a good rate when you have bad credit

Just because you don’t have the highest credit score doesn’t mean you shouldn’t shop around for the best rate. One place to start shopping is with LendingTree’s Mortgage Refinance Rates tool (Note: MagnifyMoney is a subsidiary of LendingTree).

However, you do need to ask a few more questions with rate shopping if you have bad credit. The following steps will give you the information you need to get the most accurate quotes.

  • Get rate quotes on the same day. Much like stocks, interest rates change daily, sometimes even hourly, depending on market conditions. It’s important to set aside enough time to obtain your quotes on the same day. Besides the rate itself, you want to know about the fees. Very low advertised rates will often require higher origination and other fees.
  • Make sure you are getting quotes for the same lock periods. When you receive a quote, the interest rate is generally locked in for a certain period of time. The longer period you lock, the more expensive the rate. Be sure you are getting at least a 30 to 45 day rate quote to give enough time for the appraisal and approval process.
  • Make sure information you give lenders for the rate quote is the same. Have a checklist of information you give to all of the lenders you contact: credit score, property type, value and loan amount should be the same with all of the quotes.
  • Ask if the lenders have any extra guidelines for bad credit. Be sure to tell lenders upfront if you have recent late payments on mortgages, credit cards or other negative credit issues. It’s better to know sooner if they can’t approve your loan.
  • Ask the lender if they specialize in refinances for bad credit. There are lenders that have additional experience and investor choices for bad credit. Ask a lot of questions. If you don’t get a lot of answers or feedback, move on to the next lender.
  • Make sure there are no upfront nonrefundable fees. The only fees that lenders should require before closing are the credit report and appraisal fee. Any other fees should be payable at closing.
  • Make sure you get the quotes in writing on a Loan Estimate form: Verbal rate quotes don’t hold any weight, so be sure you are comparing your rates and fees on a “Loan Estimate” form so you can compare all the offers side by side. You can also use the written estimates to negotiate between the lenders for the best terms.

The bottom line: You can refinance even with bad credit

Before you start the process, use a mortgage refinance calculator to get an idea of what the rates will be based on your credit score right now.

You will most likely have to provide more documentation with your refinance if you have bad credit. Lenders will want more proof that your income is stable, your assets are solid, your home is in good condition, and will likely require detailed explanations of all of the negative items on your credit report.

If at first you don’t succeed, try another lender. Not all mortgage lenders have access to the same programs, so getting turned down by one mortgage company doesn’t mean you won’t be able to get approved.

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