How To Refinance a Mortgage With Bad Credit
Refinancing your mortgage can be a smart financial move. Sometimes, it can lead to better mortgage loan terms and potentially reduce your monthly payments. For example, refinancing a home can help you take advantage of lower interest rates and access the equity in your home for other expenses.
But what if you have bad credit? Refinancing your home with a lower credit score can be challenging but it’s not entirely impossible. Whether you’re a first-time homeowner or have refinanced before, here are some important tips for getting the best possible mortgage refinance rates from the best bad-credit home loan lenders.
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1. Use Federally-Backed Mortgage Options
Bad credit home loans do exist, and getting one might be the best way to refinance mortgage rates and lower your monthly payments. There are a few federally-backed mortgage options for those with lower credit scores like:
FHA loans
VA loans
USDA loans
Phil Crescenzo Jr. is a Vice President at Nation One Mortgage Corporation. He says, “The most flexible loans for lower credit scores are FHA loans and for eligible Veterans, the VA loan. An FHA loan can offer credit scores as low as 580, and below in other cases with added equity and other qualifying factors.” (SOURCE)
There’s also an option for homeowners who already have an FHA loan. Josh Jampedro is the CEO of Home Loan Advisors and has been working in the mortgage and real estate industry for over a decade. He says, “Refinancing your home with bad credit can be difficult. There are a few ways to do this and it often depends on the type of loan the homeowner has currently.”
Jampedro explains how this works with the FHA streamline product, “For those who currently have FHA loans, it can be possible to refinance your home through a streamlined refinance without the need to pull a full credit report. This can be done with a ‘mortgage only’ credit report that pulls only the mortgage debt to make sure there have not been any missed payments on the existing mortgage.”
2. Fannie Mae or Freddie Mac Refi Possible Products
Borrowers with low credit scores should also consider refinancing their home mortgage through Fannie Mae’s RefiNow or Freddie Mac’s Refi Possible loan programs. These programs are designed to help homeowners with moderate incomes and lower credit scores.
Fannie Mae’s RefiNow Freddie Mac’s Refi Possible requirements:
Fannie Mae or Freddie Mac must own your loan
No minimum credit score
Debt-to-income (DTI) ratio of up to 65%
Interest rate must drop by at least reduction of at least 0.5%
A reduction in the monthly payment that includes principal, interest, and the mortgage insurance payment (if applicable)
Loans can’t be used to cash out equity
Your income can’t exceed the median income in your area.
Loan requirements may change, so consult with the Fannie Mae and Freddie Mac websites for updated borrower requirements.
3. Work With Your Current Lender
When your credit is too bad to refinance your home loan through traditional means, working with your current lender can be a viable option. Start by reaching out to explain your situation and explore potential solutions they might offer, such as a loan modification. Loan modifications can include extending the loan term or reducing the interest rate to lower your monthly payments.
The key here is being proactive and maintaining open communication with your lender. Sometimes, this can lead to more flexible loan terms, potentially reducing your monthly payments.
Be mindful that getting a loan modification can be a lengthy process, and there’s no guarantee that the lender will approve you. Going through the loan modification process often includes gathering documentation to demonstrate your financial circumstances and other information to help your lender decide what to do with your loan.
4. Work With Flexible Lenders
Finding lenders with custom loan products for borrowers with lower credit scores may help you refinance your home loan with reasonable terms. These lenders are accustomed to working with individuals who have lower credit scores and may be able to offer alternative refinancing solutions.
They may provide more personalized services and be more willing to consider factors beyond your credit score, such as your overall financial situation and your efforts to improve your credit.
These lenders may also consider compensating factors like the amount of equity in your home, the circumstances behind your lower credit score and other information related to your loan file.
In this case, you could have a higher interest rate on your new loan, but if you’ve got enough equity in your home and your payment is reduced enough, it may still be worth it.
5. Understand Your Credit Score
A credit score is a numerical representation of your creditworthiness. This number comes from your credit history and financial behavior. It ranges typically from 300 to 850, with higher scores indicating a stronger credit profile.
Credit scores give lenders a quick way to assess the risk of lending you money. Factors influencing your credit score include:
Your payment history
Amounts owed
Length of credit history
New credit accounts
Types of credit used
Borrowers with higher credit scores are considered less likely to default on loans and are often rewarded with lower interest rates and more favorable loan terms. On the other hand, borrowers with a lower credit score signal higher risk to lenders, resulting in higher interest rates and stricter loan conditions, making it more expensive to borrow money.
As you can see, this number is a major factor in determining your eligibility for various loan products, including mortgages. For this reason, improving your credit score before refinancing your home could be an extremely worthwhile effort.
6. Improve Your Credit Score
In some cases, you can make minor changes to your financial habits and get good enough results to become eligible for a refinance loan on your own. In other cases, the journey may be a little longer and require more work.
Get Help
In either case, you should know that you don’t have to go it alone. A good place to start is by getting advice from your lender since they understand mortgage underwriting requirements. They can usually tell you what to address on your credit profile to improve your eligibility for a loan. If you need more help, consider working with a reputable credit repair service or DIY credit repair app to help you improve your score.
Monitor Your Credit Regularly
A key to improving your credit is to check your credit report regularly for errors and address them as soon as possible. Get copies of your credit report from each of the three major credit bureaus–Experian, Equifax, and TransUnion–so you can thoroughly review the details for any discrepancies.
Look out for incorrect account information, duplicate entries, and unfamiliar accounts or charges. If you spot any errors, promptly file a dispute with the credit bureau to have the mistakes corrected.
Pay Down Debt
Paying down debt is another effective strategy for improving your credit score. High levels of debt, especially in relation to your credit limits, can increase your credit utilization ratio and potentially lower your score.
Start by creating a plan to pay down high-interest debt first, such as credit cards or personal loans. You may also consider using the snowball method, which focuses on paying off the smallest balances first ( contrary to the avalanche method, which targets the debts with the highest interest rates). It may also help to create a budget and allocate as much money as possible to your debt repayment efforts.
By paying down debt significantly, you can improve your credit utilization ratio–an important factor in determining your credit score–and demonstrate responsible financial behavior to potential lenders.
Make Timely Payments
Another important aspect of your credit score is your payment history, which is a huge factor in how your credit score is calculated. For this reason, consistently paying your bills on time is extremely important.
Set up reminders or automatic payments to avoid missing due dates. If you need help remembering payment deadlines, consider using budgeting apps that can help you track and manage your expenses more efficiently.
Making timely payments keeps your accounts in good standing and builds a better credit history over time, which can eventually increase your credit score. By prioritizing timely payments, you can improve your credit profile and appear much more creditworthy to lenders in the loan application process.
In sum, understanding, actively managing and improving your credit score can increase your loan approval odds, perhaps even obtaining more favorable terms.
7. Consider Alternatives
Consider a Loan Modification
When refinancing your home loan isn’t a viable option, consider a loan modification with your current lender. A loan modification involves negotiating new terms with your existing lender to make your mortgage more manageable. This could mean lowering the interest rate, extending the repayment term, or even reducing the principal balance.
Loan modifications are especially helpful for those experiencing financial hardship but wanting to stay in their home. Though the process can be complex and time-consuming, working directly with your lender or getting the help of a housing counselor can improve your chances of success.
Get a Co-Signer or a Co-Borrower
Christa Tessier owns The Mortgage AdvisorsOne (SOURCE). She says, “An effective method is to enlist a co-signer with good credit. This can enhance your application’s credibility and improve your chances of approval.”
Though this approach may not work in every situation, it may be worth a try if the lender will allow it, and it ultimately qualifies you for the loan.
Participate in Credit Counseling
Financial counselors can provide personalized advice and resources to help you manage your finances more effectively. They can assist in creating a budget, identifying areas where you can cut expenses, and helping you develop a plan to improve your credit score.
Jake Vehige is the President of Mortgage Lending at Neighbors Bank (SOURCE). He explains how his bank helps people improve their credit scores to qualify for loans.
He says, “For example, we have what we call our ‘Lighthouse’ program at Neighbors Bank. If a borrower comes to us and applies for a mortgage loan but has non-qualifying credit, our Lighthouse team works with them directly on a game plan to improve their credit.”
Vehige goes on to explain, “This is a free service we provide because, ultimately, our goal is to help as many people as possible get a mortgage or put themselves in a better financial position. For folks with lower credit, that goal might just take a few extra months working with a Lighthouse Consultant than for someone walking in with great credit.”
Work With a Debt Settlement Agency
Working with a debt settlement agency can provide relief for those struggling with excessive debt and bad credit. This service can often help overwhelmed borrowers negotiate and reduce loan balances.
Debt settlement involves negotiating with creditors to accept a lower lump-sum payment instead of the full balance owed on an account. This settlement process can potentially save borrowers significant amounts of money and help free up cash flow, which can be redirected toward other financial obligations or savings goals.
Though this service can be extremely helpful, it’s important to work with a reputable company that will help you get the best results. Debt settlement companies are notorious for charging high fees and being unable to deliver on all their debt reduction promises.
You should also know that debt settlement results can initially lead to better financial outcomes. However, it can damage borrowers ‘ credit scores since settling for less than the full amount is generally reported negatively to the credit bureaus.
Despite these drawbacks, someone with bad credit might consider debt settlement because it can provide a clear path out of debt when other options are impossible.
Get a Reverse Mortgage
For homeowners with bad credit, a reverse mortgage can be a viable alternative to refinancing their home. A reverse mortgage allows senior homeowners aged 62 or older to convert part of their home equity into cash without the need to sell the home or make monthly mortgage payments. Plus, there’s no minimum credit score to qualify.
Instead of making payments to the lender, the lender makes payments to the homeowner, effectively reversing the traditional mortgage process. This kind of loan can help those whose main goal is to have more cash on hand to cover daily living expenses.
Eligibility requirements for reverse mortgages:
Age: The homeowner must be at least 62 years old.
Primary residence: The home must be the borrower’s primary residence.
Home equity: A substantial amount of home equity is necessary since the amount you can borrow depends largely on the value of your home.
Financial assessment: Lenders will conduct a financial assessment to ensure borrowers can continue to pay property taxes and homeowner’s insurance and maintain the property while having a reverse mortgage loan.
Counseling session: Borrowers must participate in a counseling session with a HUD-approved counselor to ensure they fully understand the reverse mortgage process and the possible outcomes.
Reverse mortgages can be very helpful to those struggling with poor credit. These loan products allow borrowers to access needed funds without the credit requirements of traditional mortgage refinancing.
Ask about HARP
The Home Affordable Refinance Program (HARP) is a mortgage refinance qualification program designed for homeowners who are currently on their mortgages but still owe much more than what their homes are worth. Those who qualify for the HARP program could restructure loan terms if the money was borrowed from a bank, credit union, or mortgage company owned by Fannie Mae or Freddie Mac. Refinancing through HARP 2.0, the recently revamped version of the program, could help you save money on mortgage rates even if your credit isn’t stellar.
Apply for HAMP
If your current loan payment has become unaffordable and you’re struggling to stay out of foreclosure, you might qualify for the Home Affordable Modification Program. HAMP can help reduce your monthly payments to a percentage of your pre-tax monthly income. Instead of a traditional refinance, HAMP offers loan modifications, which can include a different interest rate, loan balance and loan terms.
Mortgage modifications are a good alternative to bad credit home loans because modification interest rates can be lower than the current mortgage rate trend. Some HAMP recipients see interest rates reduced to as low as 2 percent to avoid foreclosure and then gradually increase after five years.
The Bottom Line
Refinancing a mortgage with bad credit can present many challenges to borrowers. With some determination and creativity, you can overcome these challenges and reach your financial goals–whether through refinancing your home or finding another suitable alternative.
Aja McClanahan contributed to the reporting of this article.
FAQ
Can I refinance with a 500 credit score?
Refinancing with a 500 credit score is challenging but possible. You may consider FHA loans, which often have more lenient credit requirements, or explore options with non-traditional lenders for alternative solutions.
What is the minimum credit score to refinance a mortgage?
The minimum credit score to refinance a mortgage varies by lender, but many require at least 620. Some government programs like FHA may allow lower scores, usually around 580 or even lower under certain conditions. Always check specific lender requirements.
Does refinancing hurt your credit?
Refinancing can temporarily hurt your credit due to hard inquiries and reduced average account age. However, the impact should be minor and temporary if you make timely payments on your new loan.
Can I refinance my house without a credit check?
Most traditional lenders require a credit check for refinancing. However, there are some niche lenders and specific programs that may allow refinancing without a strict credit check.
What are the alternatives to refinance a mortgage?
Alternatives include loan modification programs, reverse mortgages for seniors, home equity lines of credit (HELOCs) or personal loans.
How can I borrow money without refinancing?
You can borrow money without refinancing your home by taking out a home equity loan, getting a personal loan, applying for a reverse mortgage (for eligible borrowers) or using a line of credit.
This article originally appeared on GOBankingRates.com: How To Refinance a Mortgage With Bad Credit