There are many reasons why you might want to refinance your mortgage. Maybe you want a shorter mortgage term or lower interest rates, or maybe you want to consolidate your debt. Whatever your reason may be, refinancing your mortgage could potentially save you thousands of dollars over the life of your loan.
Because you’re essentially using a new loan to pay off an existing loan, you might have the assumption that refinancing your mortgage is not an option for you if you have bad credit. However, that isn’t always the case.
Get a cosigner
Cosigners can help you look good when you have bad credit. Banks see them as a safety net, taking away the risk associated with your low credit history. In this case, cosigners don’t need to own the home; they are only responsible for the loan.
As always, it’s more helpful for you if your cosigner has a better credit history and higher income than you do. It’s a serious commitment, which means it might also be helpful to choose someone with whom you have a strong bond so that an occasional late payment won’t jeopardize your relationship.
Take advantage of the FHA Streamline Finance Program
The Federal Housing Administration (FHA) Streamline Finance Program is pretty much what it sounds like. It exists so that people with low credit can reduce the interest rate on their current home loan. It’s not a free-for-all, though, and has a few conditions:
- Your original home loan must be an FHA loan in good standing.
- The refinance has to lower your monthly loan payments.
- You can’t receive cash back.
- FHA requires an upfront premium that is equal to 2.25 percent of the loan amount.
- You might have to pay a monthly premium as well.
So, if you have bad credit but not too much debt, then the Streamline Finance Program might be a good fit for you.
Tell the whole story
Your credit score isn’t the only factor that banks consider when looking at your mortgage application. Chances are that there are other aspects of your financial history that you can highlight to counteract your low credit score.
Emphasize the length of your employment history (the longer, the better), show proof of consistent on-time loan payments, tell them about an upcoming raise and show proof of savings. Use your application as a space to explain any delinquencies. You’d be surprised how well that can work in your favor.
The point is that a low credit score doesn’t have to be the end of the world. And, if that’s the only blemish on your financial record, then you’re in good standing to be able to refinance your mortgage.
Life happens. You might have a low credit score and your finances might not be great either. If that’s the case, consider waiting a year to apply and take steps towards lowering your credit score and strengthening your financial profile—minimize debts, make consistent on-time loan payments, make sure your mortgage is not higher than 30% of your income and put a little bit into your savings every month.
After a year of making these financial gains, you can then apply to refinance your mortgage. Because a mortgage application can set you back a few hundred dollars, it’s wise to ensure that your application is as strong as it can be. Sometimes, it’s all about planning for the long-term.
Things to keep in mind
Equity is one of the most important aspects of your mortgage application. This is because new home loans are based on the current market value of your house. That means that you need to owe less on the property than its value for a bank to consider refinancing your mortgage. If you owe more than your house is worth, then the bank will consider a new loan to be too risky.
You don’t need as much equity if you have high credit—around 20% equity will do. However, you’ll need more than 20% if your credit is on the low end of the spectrum.
When you have low credit and want to refinance your mortgage, it helps to keep your expectations low.
In an article for Ebony, money coach and owner of the financial blog Askthemoneycoach.com Lynnette Khalfani-Cox gave a frank view of the mortgage industry: “The very best, low-interest rate mortgages are reserved for pristine borrowers.”
This is not meant to discourage you. In fact, it helps you know what you’re up against. You might not be able to secure the lowest interest rates, but bad credit is not a financial death sentence. All it means is that you have to work harder and be a little more creative when trying to refinance your mortgage.