Refinancing your mortgage can provide you with a lot of financial benefits. For example, you can cash out on some of your home’s equity when you need a large sum of money.
You can also take advantage of lower interest rates to save on your monthly payments. It’s also possible to get rid of your private mortgage insurance if you have enough equity in your home.
It may be difficult to refinance if your credit has taken a dive since you first bought your house. After all, you’ll essentially be taking out a new home loan and will have to go through the entire application process with a mortgage lender.
However, you’re not left without any options. Learn how to make sure refinancing is the right move for you and how you can refinance your mortgage with bad credit.
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 mortgage payments with a lower interest rate. However, remember that you also have to pay closing costs and other fees to get a new loan.
Refinancing Usually Extends Your Loan Term
Also, consider that your newly refinanced loan usually extends the length of your loan back to 30 years. This is regardless of how long you have been paying down your current loan. That means it will take longer to pay off your house, and you’ll also be paying that interest for longer.
If you’ve been paying on your home for 10 years, that’s a lot of time to add back onto your mortgage. You’ll also have to pay more in interest. So, before you refinance, make sure you consider all 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 deciding.
Refinance a Mortgage 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 excellent credit, you still might be able to get approved for a home loan.
Start by shopping around for mortgage lenders. You’re under no obligation to use the same lender as your initial mortgage, and it’s good to compare several offers.
Refinanced home loans can be structured in several 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.
If you intend to stay in your home for a long time, it may be worth paying an extra point at closing to get a better interest rate. Think about what your goals are in refinancing. Talk to each lender about the different ways you can achieve them.
A good loan officer can also help you prepare for mortgage refinance approval, even with a lower credit score. If you can, demonstrate that you have strong cash reserves by putting extra money in the bank.
Mortgage lenders are more likely to approve you for a mortgage loan if you have money on hand that is accessible. It shows that you’ll be able to pay for your loan even if your monthly budget is tight at times.
Pay Off Debt
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 you should only spend 41% of your pre-tax income on recurring debt payments (such as a mortgage, credit card minimums, and personal loans).
Suppose you earn $5,000 a month before taxes and health insurance, 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 lenders’ required minimum.
To strengthen your application, consider making a few extra payments to lower your debt amount even more. However, your credit report may not reflect those numbers for a few months, so ask your lender to perform a rapid rescore if you’re in a hurry.
Getting a Cosigner
If a bad credit score is still holding you back from refinancing a mortgage, you also have the option of applying with a non-occupying cosigner.
This basically means that someone else with better credit history can help get you approved without having to be an owner of the property title. However, 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. If you can’t make your monthly payment, your cosigner’s credit score will also suffer; even if the loan goes to foreclosure.
Having a strong, trusting relationship with your cosigner is imperative. Discuss with them what might happen in the 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 loan officer 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 through a traditional lender, check to see if you qualify for one of these government-sponsored programs.
These options for refinancing a mortgage are specifically aimed to help people with bad credit. Each mortgage refinance option has different requirements, so read carefully before proceeding. If you qualify, you might be able to take advantage of significant savings.
This program is specially designed to benefit homeowners whose mortgage is greater than the value of the home, so there are no restrictions 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).
FHA Rate and Term Refinance
If you already have an existing FHA loan, you may be able to qualify for an FHA Rate and Term Refinance. This option allows you to change the terms of your current FHA loan and replace them with more favorable terms. The minimum credit score to qualify is 580.
FHA Streamline Refinance Loans
If your current mortgage is not an FHA loan, you may be able to refinance your mortgage with an FHA Streamline Refinance. The minimum credit score requirement is also 580. An FHA streamline refinance can help lower your interest rate. Additionally, it’s possible to get approved without an appraisal, credit check, or income verification.
FHA Cash-Out Refinance Loans
You can also do an FHA cash-out refinance if you have a minimum credit score of at least 620. This can be done whether you have a conventional loan or existing VA loan.
The cash-out refinance allows homeowners with equity in their house to receive a lump sum of cash. This is done by increasing the principal mortgage amount (and, consequently, monthly payments).
VA Interest Rate Reduction Refinance Loan (VA IRRRL)
Interest rate reduction refinance loans (IRRRLs) may be a viable option if you have an existing VA loan. These are also known as VA Streamline Refinances. They are backed by the U.S. Department of Veterans Affairs. You can also move from a loan with an adjustable or variable interest rate.
Basically, a VA Interest Rate Reduction Loan lets you replace your current loan with a new one under different terms.
To qualify for the VA IRRRL, you must meet certain requirements. You must have a VA loan. The last six consecutive mortgage payments must have been made on time.
Furthermore, refinancing must occur at least 210 days after your first payment on your original loan, and you can’t take cash out with this refinance.
USDA Streamlined Assist Program
The USDA Streamlined Assist Program is a loan program designed to help low-income rural families purchase homes in eligible rural areas. The program is administered by the United States Department of Agriculture (USDA) and is available for single-family dwellings, manufactured homes, and some condominiums.
The program offers 100% financing and low interest rates, with the average loan amount being around $150,000. The program also features flexible credit requirements, allowing applicants with low or no credit scores to still qualify.
In addition, this program does not require a new appraisal or home inspection, nor does it consider your debt-to-income ratio when determining eligibility. The program also provides counseling to assist borrowers in understanding the loan process.
Improve Your Credit Score Before Refinancing
If you were denied a refinance or want to qualify for even lower interest rates, 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 credit score.
Hire a Credit Repair Company
Credit repair companies may be helpful for people with numerous negative items on their credit reports. They can help you dispute those items and possibly remove them altogether. Have a look at our reviews of the leading credit repair companies.
Credit scores are often categorized into five different ranges, from bad to excellent. If you increase your credit score enough to move into the next category, you could automatically qualify for better refinance 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.
Should you refinance with bad credit?
If you have bad credit, you may be wondering about the pros and cons of refinancing. Whether you want lower monthly payments or to eliminate mortgage insurance, refinancing now could be a critical step in improving your credit. Plus, you could save money in the long run.
However, it’s important to remember that refinancing also comes with costs. Consider all the factors and use a mortgage refinance calculator to estimate your savings before you decide.