Although a low credit score is not a barrier to refinancing a mortgage, it can be enough to discourage homeowners from even contemplating it.
After all, a credit score is a crucial consideration for lenders. Why even try if you already know you have bad credit for the greatest purchase of most people’s lives?
When you apply for a mortgage or to refinance a home loan, your credit is just one piece of the jigsaw. There are initiatives to assist persons with weak credit in refinancing their mortgages, and numerous other variables are taken into account.
Here are several methods for refinancing a home loan even with bad credit:
Understand your credit score.
Even though the refinancing program doesn’t depend on your credit, a lender will still request a copy of your credit report when you apply, according to Randall Yates, CEO of The Lenders Network.
According to the Ellie Mae Origination Insight report for January 2017, here is a breakdown of mortgage refinances by credit card score:
|Mortgage Refinances by Credit Score|
|FICO® Score Range||% of Borrowers|
Borrowers with credit scores between 650 and 699 accounted for over one fifth of all refinances of mortgages.
A lending program that takes a low credit score into consideration is how the majority of borrowers with bad credit obtain their mortgages. You might be able to use such programs to refinance at a cheaper interest rate.
Streamlined FHA Refinance
First-time homebuyers with credit scores in the low 500s may qualify for an FHA loan, which is insured by the Federal Housing Administration. However, a score of 580 or higher will reduce the down payment required from 10% to 3.5%. Mortgage insurance, which is necessary for FHA loans and raises the total cost of the loan by protecting the lender in the event of a borrower failure, is required.
According to Yates, the FHA Streamline Refinance program enables borrowers of FHA home loans to refinance swiftly. A credit check, proof of job or income, or an evaluation of the residence are not necessary. Even if the home is now worth less, the initial purchase price can be utilized as its current valuation.
Yates asserts, “You can qualify even if you’re upside down on your mortgage.”
According to him, the program takes 30 days to complete and is designed to prevent foreclosures. Typically, a refi takes 45 to 50 days.
A mortgage statement is the most crucial document you’ll need to present. According to Yates, one late mortgage payment is permitted in the previous 12 months, but not in the previous six. The amount of documentation is low aside from that.
According to him, the refinance is “based on the real loan rather than the individual.”
According to Ellie Mae, the majority of FHA loans in January 2017 (36.26%) went to borrowers with credit scores between 650 and 699. About 19% and 23.92% of people had credit ratings between 600 and 649 and 700 and 749, respectively.
Other simplified refinancing initiatives
The rationale behind the FHA streamline refinance program is that reduced interest rates should result in smaller monthly payments, which should prevent as many loans from defaulting.
Similar objectives can be seen in other home financing programs for buyers with low to moderate incomes.
Simplified refinancing is available through the VA home loan program for veterans and the USDA home loan program in suburban and rural areas. The USDA streamline program began in 2012 in 34 states before being implemented nationally this year.
You might be qualified for a refinance through the Home Affordable Refinance Program, or HARP, if your mortgage is underwater—you owe more on it than the house is worth—and you’re current on your payments.
But time is running short. The federal initiative is scheduled to end on September 30, 2017. In order to keep their houses, the program is designed to assist struggling homeowners who want to refinance at cheaper interest rates.
Fannie Mae or Freddie Mac guarantee the loans. Homeowners must have kept up with their mortgage payments, with no more than one delinquency in the previous year and no more than one in the previous six months.
According to Yates, there is no minimum credit score requirement, and the program is open to all qualifying borrowers, even those with little to no equity or underwater mortgages. Along with your income and work, your credit history will also be examined.
For homeowners with poor credit, using the HARP program to refinance their loan and obtain a lower interest rate and monthly payment is a terrific alternative, according to him.
The following criteria apply in addition to the payment requirements mentioned above (speak to a lender to discuss any additional eligibility requirements):
- Your loan must be held by either Freddie Mac or Fannie Mae.
- Your loan’s origination date must be on or before May 31, 2009
- The refinance must increase the loan’s stability or long-term affordability (lower the payment or convert from variable to fixed, for example)
- The new loan must continue to be held by at least one original borrower.
The HARP program may be available for investment properties and second residences.
Change the loan
According to Ray Rodriguez, regional sales manager for TD Bank in New York City, recasting a loan is a technique to reset the principal amount by making a sizable lump sum payment and then recalculating the reduced monthly mortgage payment under the same terms as the original loan.
The loan can be recast at the lower balance, for instance, if you earned a sizable tax refund or bonus at work and want to apply it to the principal balance of your mortgage. The loan’s term and interest rate don’t change, but the monthly payment does.
According to Rodriguez, the cost of a recast might be much lower than that of a mortgage refinance, at just a few hundred dollars.
Reduce your debt
The debt-to-income ratio, or DTI, is calculated by dividing your total monthly debt payments by your gross monthly income (before taxes). A mortgage or refinance application’s DTI rating can make or break it.
There are two approaches to compute DTI. Your monthly income divided by the total cost of your housing constitutes the front-end ratio. Housing expenditures include the loan payment you desire (principal, interest, property taxes, and mortgage insurance), as well as any HOA dues and homeowners insurance. The majority of lenders prefer front-end ratios of 28% or lower (31% or less for FHA loans).
Your total monthly debt payments divided by your monthly take-home pay is known as the back-end ratio. Housing costs, credit card minimum payments, child support, automobile and school loan payments, as well as any other loans or debt repayments, all count as debt payments. Typically, lenders prefer to see a back-end ratio of 33% or less (45 percent for FHA loans).
DTI is distinct from the utilization ratio used to calculate your credit score. That represents your credit card debt as a percentage of available credit. Rodriguez from TD Bank advises clients to take every step possible to raise their credit score before refinancing a mortgage. Getting your credit usage rate as low as you can is part of it.
Your debt-to-income ratio and utilization ratio will both increase if your credit card balances are reduced, as will your credit score.
A different credit fix
Don’t skip payments on your credit cards, and refrain from applying for new ones while you’re considering a refinance.
When refinancing, it makes sense to look for lenders with the lowest rates, but you should only shop around for mortgage rates for 30 days.
This is due to the fact that initial 30-day mortgage lender queries are disregarded when calculating your credit score. After that, multiple credit-scoring queries from mortgage lenders done within 30 days will only count as one.
Notably, the purchasing window for VantageScore® is 14 days, whereas the window for the most recent FICO® version is 45 days.
Keep in mind that a credit score is just one piece of the refinancing puzzle for a mortgage. To establish the loan rate or whether you are eligible for a new loan at all, lenders will also take into account your employment history, income, assets, and DTI. If you have trouble meeting the requirements on one aspect (like credit score), you might be able to make up for the deficiency with another (such as the size of the down payment).
There are some explanations for credit score declines. A lender may overlook a one-time incident, such as an illness that forced you to incur debt to pay medical expenditures, according to Rodriguez.
You shouldn’t let a low credit score deter you from trying to refinance your mortgage to a lower rate on its own. There are ways to avoid it or make it better, and your lender can teach you how to do so.