Refinance with Bad Credit - Can I do It?
Who doesn’t want to save money? Refinancing your mortgage loan into a lower interest rate and/or a lower period can save you money. Alternatively, you can lower your monthly payment by taking out a longer period loan. Given today’s low mortgage rates (2012 has record low rates) you can both lower your payment and save on your financial costs.
However, refinancing with bad credit is not an easy chore. If you have bad credit and an underwater house or high LTV, then refinancing is even more challenging. Even if you can find a lender who offers bad credit loans, your financing costs are going to be high.
In order to help you refinance with bad credit and avoid making costly mistakes, learn:
- What is Bad Credit
- Special Products to help you Refinance with Poor Credit
- Improving your credit – Going from Refinance with Bad Credit to Refinance with Good Credit
What is Bad Credit
A bad FICO score is a common response because lenders screen you by asking about your credit score. However, bad credit is more complex and involves your:
- credit history and credit score
- debt to income
Credit History and Credit Score
As the Credit Reporting Agency (CRA) Experian explain on their website, your credit score is derived from your credit history. Your FICO credit score is based on five main elements:
- Timely payments: Make sure that you make all your payments on time
- Credit utilization: Keep your balances low and not more than 30% of available credit.
- Length of Credit History: Keep your credit lines active. It is better not to suddenly close credit lines.
- Credit Mix: Take out different types of credit such as a mortgage, auto loan, and credit cards.
- New Credit: Don’t suddenly take out lots of new credit. Also having your credit pulled will lower your score.
The CRA collects data that is presented in your credit report. Based on your past performance a credit score is determined to help the lender predict how you will pay on future loans. Past negative information is generally kept on your credit report for 7 ½ years, although a bankruptcy and public judgments can stay for a longer period. Negative information includes late payments (e.g. 30-day or 60-day), charge-off and collection items, settled accounts, public records, bankruptcy, and foreclosures. Those negative accounts harm your credit score, and sometimes prevent a lender from offering you a loan. Although paying off a collection will harm your score, your lender may require a cleaner credit report.
Debt to Income Ratio
If you have too much debt, then a lender will consider you a high-risk borrower. Your DTI ratio is calculated as follows:
- Front-end DTI: Divide your total monthly housing expenses (mortgage principal and interest payment, property insurance, property tax, homeowner association fees, and mortgage insurance) by your monthly income. A FHA loan has a 29% limit on your upfront DTI ratio.
- Total DTI: Divide your total monthly housing expenses plus your monthly payments for other debt (credit cards, student loans, auto loans and installment credit) by your monthly income. A FHA loan requires a DTI under 43%.
Underwriting requirements vary by loan and lender. If your monthly income comes from a stable employment you hold for more than 2 years, then it is easy to calculate. However self-employed or investment income is harder to determine. You will need to work out the details with your lender.
Special Products - Refinance with Poor Credit
Refinancing with bad credit is a challenge. Most conventional loans are not an option if you have poor credit. Other loans come with high interest rates that make refinancing expensive and not financially worthwhile.
However, there are special products to help you refinance with bad credit. Remember though, many lenders will add their own requirements, so you will need to shop around for a lender who will meet your needs. Here are some of the products:
|HARP 2.0 Refinance Mortgage Loan||Must be a Fannie Mae or Freddie Mac loan originated before June 1, 2009.|| A manual loan done through your original lender / current servicer has no DTI or credit score requirements. |
A loan done through a new lender has stricter requirements including a maximum DTI of 45%
|FHA Streamline Loan||Must be a FHA loan||The FHA Streamline loan doe not have a credit check or minimum credit score. It also allows for unlimited LTV.|
|VA Streamline Loan or IRRRL (Interest Rate Reduction Refinancing Loan)||Must be a VA loan.||The VA loan does not require any analysis of the borrower's credit worthiness or an appraisal report. The loan must have an interest rate reduction or move you into a more stable loan.|
|FHA Refinance Loan||LTV ratio up to 97.5%||FHA loans have less strict credit history requirements than conventional loans. The minimum FICO score is 580, although many lenders have stricter requirements. FHA loan have a large upfront mortgage insurance and high annual premiums.|
Going from Refinance with Bad Credit to Refinance with Good Credit
Refinancing with bad credit is not always a good idea. A lower credit score means a higher interest rate, higher fees and a higher monthly payment. If you have bad credit then you will have to work harder to get a better deal. Explain to your lender your situation and any compensating factors that make you a better borrower.
Before refinancing your loan, prepare yourself. Take steps to improve your credit including:
- Monitor your credit report and credit score.
- Dispute any incorrect items on your credit report.
- Attempt a pay for delete to erase old negative tradelines.
- Make all of your payments on time.
- Lower your debt level. Pay down credit cards and avoid making minimum payments.
Read the Bills.com article qualifying for a refinance loan and follow the five BILLS steps:
- Build your budget
- Improve your DTI ratio
- Learn your credit score and history
- Learn your home’s value
- Shop around
You can fix your bad credit, but it takes time. Be patient, prepare yourself, look for specialloans that meet your situation, and work on moving from bad credit to good credit.