Refinancing a home with less-than-perfect credit
How to refinance with bad credit
- Do all you can to improve your credit score.
- Consider asking a friend or relative to co-sign your refinanced loan.
- Use cash or other assets as collateral.
- Consider the streamline refinance program, which helps FHA-insured borrowers with problematic credit.
If your financial situation has slipped since you purchased your home, you may benefit more than many people from refinancing your home mortgage to take advantage of low interest rates and potentially lower monthly payments. But what if the change in circumstances also has hit your credit rating? Do you still have a shot at finding a better mortgage?
The short answer is that it's possible, but not easy, and that your prospects are much better if your mortgage is insured by the Federal Housing Administration (FHA). In any case, with not-so-good, bad or poor credit, you will not get the best available interest rates. If you can line up a loan at even a percentage point lower than your current mortgage, refinancing might still make sense.
How can I improve my credit score?
It's easier said than done, of course, but the best way to assure that you'll get the most attractive refinancing loans is to make sure you have a good credit score before comparing lenders. The term gets thrown around a lot, but it's worth reviewing what is meant by your credit score and how it's calculated.
The three main credit bureaus, Equifax, Experian and TransUnion rate consumers based on their credit history and are obligated to give you one free credit report per year. A crucial part of the report is your FICO score, which ranges from 300 (poor credit) to 850 (perfect credit).
The FICO score is based on a number of different weighted factors:
- Payment history (35 percent): Simply put, do you pay your bills on time?
- Amount owned (30 percent): Are you close to maxing out your credit cards, or otherwise overextended?
- Length of credit history (15 percent): The longer the better, for the most part.
- Credit mix (10 percent): You're better off if you have experience with both installment loans and revolving credit, like credit cards.
- New credit (10 percent): You're seen as a bigger risk if you have obtained a significant amount of credit recently, especially if you do not have a long credit history.
If your credit score is not where you want it to be, there are some things you can do to improve it relatively quickly. Most importantly, pay your bills on time; make more than the minimum payment whenever possible and get credit card balances down to no more than 30 percent of your credit limit; limit the number of inquiries you make to the credit bureaus; and check your credit report closely to identify and remove any incorrect information.
Can I refinance an FHA loan?
If your loan is insured by the FHA, there is a program offered by most FHA lenders that will allow you to refinance regardless of your credit rating.
An FHA Streamline refinance loan is available to any borrower who is up-to-date in payments on an FHA-insured mortgage. The Streamline loans are about a simple as they come — they do not require credit checks, income verification or home appraisals.
To qualify, borrowers must show a "net tangible benefit" from the refinancing, such as a lower interest rate or a move to a fixed from an adjustable-rate mortgage. Unlike the refinancing available from banks, the FHA loans cannot be used to turn home equity into cash.
How else can I refinance with bad credit?
If you cannot find a lender who specializes in bad-credit loans to help you, and an FHA refinance or a quick improvement to your credit score is out of the question, another alternative is persuading a friend or family member to co-sign your refinanced loan. That is a big help in your credit application, depending in the creditworthiness of your co-signer, but it is also a big responsibility for your friend or relative. They will be on the hook for at least a portion of the loan, although they do not have a claim on your property.
Finally, if you have cash or other assets you can turn into cash, let the bank know you have it, ideally through a deposit. The idea is to show the bank you have the ability to repay the loan and, if necessary, are willing to pledge it as collateral, even though you may not have the necessary income or credit rating.