Refinancing with Bad Credit or No Credit

BILL'S ANSWER

Your question touches on a lot of issues. I will attempt to address the issues your question raises and make some general comments, too.

FHA Loans are Ideal for People With Bad Credit

First, I suggest that anyone with less than good credit look at FHA or Government Loan programs. FHA loans are available to people with bad credit, where bad credit can disqualify a person from most loan programs. Please read about FHA mortgages.

Co-Borrowers on a Loan

You asked if it is possible to refinance in both names, with your ex-spouse who does not have “a lot” of credit. It is not clear what you mean when by “a lot” of credit. Does your ex-spouse have three active trade lines on his credit report? A FICO score? If so, is the credit score excellent, poor, or somewhere in between?

It may be possible for the two of you to qualify together for a loan as co-borrowers, but what kind of loan will depend on the income each of you earn, the credit scores both of you have, and the equity available in your home. When co-borrowers apply for a loan, the lender uses the lowest credit score of the two applicants. Therefore, if your ex-spouse has a low score, the loan the two you could obtain, if any, may be at a worse interest rate than your current mortgage. In general, the workaround for this problem is to have the person with the better score apply for the loan by themselves and keep the borrower with the lower score on title only. Obviously, this does not apply to your situation, as you already are the only person on the loan.

Being a Co-Borrower Affects Your Debt-to-Income Ratio

If you are able to refinance with the two of you on the loan as co-borrowers, then that creates problems for you regarding the other home that you want to purchase. Your current home mortgage will appear on your credit report as a liability. The lender on any loan for the new home you wish to buy will count the current home mortgage payment as part of your debt to income ratio. Although it may be the case that your ex-husband will be making the payments, the problem is that the bank will still consider you responsible for the mortgage payments as well. Depending on your income, you may not qualify for a purchase loan if the bank feels it too risky to lend you more money. The risk is that you could have to pay two mortgages at the same time and may not have the income to cover that expense.

It may be advisable for your ex-husband to build up his credit first, along with saving money towards a down payment, in order for him to purchase the property from you on his own.

How a Credit Score is Calculated

As your question touches on credit scores, let me give you some information on how it is calculated. It is important to understand how your credit score is calculated, so you can take the proper steps to protect and improve your score. Your credit rating is calculated based on several variables, including:

Payment history: 35%

The most heavily weighted factor used in calculating your credit score. Consistently paying your bills on time has a positive influence on your score, while late or missed payments will hurt you in this area. If you have delinquent payments, the older the delinquency the less the negative impact on your score will be. Collection accounts and bankruptcy filings are also taken into consideration when analyzing your payment history.

Credit utilization: 30%

This section looks at how much debt you have compared to the total available credit on your accounts. If all of your accounts are maxed out, you will be considered a poor credit risk, because it appears that you are struggling to pay off the debt you have already incurred. If your account balances are relatively low compared to your available credit, this part of the risk analysis should help your overall credit score. The score calculation also looks at these two factors independently. Having too much available credit, whether you have used it or not, could hurt your credit score, as statistical studies have shown that people with excessive amounts of available credit are a higher credit risk. Unfortunately, the bureaus do not define exactly what they consider excessive, so best tip is to use credit conservatively and to keep your debt to credit limit ratio low.

Length of time of accounts have been active: 15%

The longer you maintain accounts in good standing, the better your score will be. This shows that you are able to make a long-term commitment to a creditor and are consistently responsible about making your payments. If you have accounts with long history (5 or more years) and no missed payments, you should keep these open and paid off.

Variety of accounts: 10%

Having several different types of credit, such a credit cards, consumer loans, and secured debt, will have a positive influence on your credit score. Having too much of one type of credit can have a negative impact.

The number of accounts that have opened recently: 10%

Applying for too much new credit in a short time period makes indicates that you could be credit risk, as you may be desperately trying to keep your head above water. The models make an exception for people who are shopping around for a loan, so if you are simply applying to see who can give you the best rate on a new loan, you need not worry too much about damaging your credit score.

Six Steps to Better Credit

Your ex-spouse may need to take steps to improve his credit score. Here is a brief outline of six basic steps to building and maintaining credit.

1) Obtain and use a credit card wisely

To start building good credit with your credit card, you will need to obtain the card, use it, and make the first payment before you will see any effect on your credit score. If you have no credit history, you may have to sign up for a “secured card” as a first step. A secured credit card is one that requires you to deposit money (typically a minimum of around $300) into an account controlled by the credit card company or bank to even obtain the card. This deposit "secures" any debt you place on the card. It is a way for a creditor to lessen risk when dealing with someone who has poor credit or no credit.

A secured card is just as good as any other credit card when it comes to building credit. Like with any credit card, the payment history on your secured card is reported to the credit bureaus. By making on-time payments (on-time payments are the No. 1 factor in determining a credit score) and carrying a low debt load (your debt balance-to-credit limit ratio is also a big credit score component), you build the history and profile that produces good credit.

Another way to build credit from scratch can include getting a low-limit retail store card or a gas card. Just be sure to pay the monthly balance in full so as to avoid the high monthly interest charges that many of these types of cards carry.

You can also build your credit score, by having someone co-sign on a debt with you. Because the co-signer takes full responsibility to repay the debt, if you do not, co-signing is risky and is something that the co-signer should be wary of doing. Every person who considers co-signing on a loan should make sure to understand the risks of co-signing. Still, the risks for the co-signer does not reduce the positive effects for your credit score of having a co-signed account report in good standing to the credit bureaus.

2) Review your credit report regularly

Review your credit report once a year. The higher your credit score, the better. A score below 680 usually results in a borrower being charged a higher interest rate or denied credit. If the report includes items that are inaccurate, request the report be corrected. You can receive a free copy of your credit report at AnnualCreditReport.com, where you are entitled to one free report from each of the three bureaus every year. I recommend that you stagger your requests, accessing one report every four months in an alternating fashion. Bills.com has some terrific information about how to dispute items on your credit report.

3) Borrow money and pay it back

Another good way to build credit history is to pay off a small loan. Borrow from your bank or credit union to purchase a used car or a larger purchase, such as an appliance. Pay the loan on time and in full. Pay any student loans on time every month. (Remember: On-time payments are the No. 1 factor in determining a credit score.)

4) Maintain a stable employment history

A stable job history is another factor that lenders will consider when giving a loan. Creditors look at job history to understand a consumer’s stability and income.

5) Guard against identity theft

Identity theft is at an all-time high, and it can destroy credit ratings. Remember that identity theft occurs both “offline,” and through the Internet. Protect yourself from unscrupulous individuals who could go through your trash, steal account numbers online or get personal information through complex “phishing” scams. Record all important financial information and account numbers in a secure place. Shred all documents that contain personal information. Never give out personal information in e-mails or in a phone call you did not initiate.

6) Establish a budget

A good way to maintain a healthy financial lifestyle is to create — and stick to — a household budget. Many people fall into credit score disarray by spending beyond their means, building up debts, and maxing out credit cards. In budgeting, list ongoing monthly expenses (fixed expenses like rent or mortgage payments). Add variable expenses that are “must-buys” (food, gas, medicine). Leave two categories for savings and spending cash (for unexpected expenses and entertainment). Add monthly net income (the amount left after taxes and other paycheck deductions such as health insurance and 401(k) contributions). A free budget guide is available at Bills.com.

To learn more about credit reports, credit scoring, and what it means to you, I encourage you to explore the wealth of material offered at the Bills.com credit resource page. Finally, spend a few minutes to learn if a no-cost mortgage is right for your situation.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com