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Refinancing Mortgages with Bad Credit
29 May 2019

The Complete Guide to Refinancing Mortgages with Bad Credit

Since your credit score is a fundamental consideration for lenders, one can wonder whether refinancing mortgages with bad credit is possible. The truth is that a low credit score is not an ultimate barrier to refinancing your mortgage.

Refinancing remains a popular method of obtaining favorable terms for an existing mortgage loan in the United States. Its value was around $111 billion in 2018.

Apart from creditworthiness, many factors come into play when applying for a home loan or refinancing. There also exists programs that help individuals with low ratings to refinance their mortgages.

This guide explains what mortgage refinancing is and explains the options for a person with bad credit. Let’s get started.

What Is Mortgage Refinancing?

Refinancing is a loan that allows you to settle an existing mortgage and replace it with a more manageable one. The new plan can come with a different interest rate and payment period among other terms.

Mortgage refinancing can come with substantial benefits in the long run. A reduced interest can lower the amount payable. On the other hand, reduced payments allow you to pay off with less pressure.

Another perk of refinancing is that you may change from an adjustable rate mortgage to a fixed rate loan and vice versa. As a result, the interest becomes predictable.

With refinancing, you may end up paying less than what you would have in the initial mortgage plan.

Mortgage Loan Versus Refinancing

In most cases, your credit score must be over 620 to qualify for a fixed-rate home loan. A Federal Housing Administration (FHA) mortgage loan requires a rating of 580.

When considering refinancing, a score of 620 is poor while 600 and below is deemed to be bad. More factors influence the decision of the financier on your approval.

Some considerations are strictly for refinancing mortgages with bad credit while others apply to new loans as well. Below are some of them.

  • Debt to income ratio (DTI)
  • Your equity in your home
  • Loan to value ratio (LTV)
  • The type of your current mortgage
  • The amount in your savings account

Don’t expect the best terms when you have a bad credit history. You need to examine the available offer to determine if it positions you better or it aggravates your rating.

If your LTV is higher than 80 percent, for example, you may have to subscribe to private mortgage insurance.

There are several approaches to financing mortgages with bad credit. Let’s looks at the most appropriate ones.

Fix Your Credit Score

Most lenders check your credit score even if the loan you are applying does not necessitate it. Before applying for a mortgage refinance, do what you can to raise your rating.

Credit bureaus can process a credit report for you and give recommendations for improvement. If you disagree with the outcome, dispute the errors and have them corrected.

Before going for refinancing, make on-time payments for loans and bills for 12 months. An attractive payment history improves your credit score which in turn earns you lower rates in the refinancing program.

Approach Your Current Lender

It’s best to give priority to your original lender. Bad credit won’t necessarily break your relationship with your financial institution. Since you are their customer, they may be ready to work with you.

Despite your credit score, they can consider you if you have a history of timely payments. The lender may offer a tailored streamlined refinancing, or you may get new terms and interest rate.

Lenders investigate your current employment and income, debt to value ratio, and loan to value ratio. With an understanding of these conditions, you will have values to compare with other lenders if you have to check elsewhere.

It’s also advisable to keep your first lender if the interest is competitive. Moving to a different one will attract transfer costs. You will also pay to open a new escrow account for the payment of insurance fees and property taxes.

Refinance an FHA Mortgage Loan

You have some options for refinancing when you have an existing federal housing administration loan. The conditions for qualifying for refinancing via the FHA program are more lenient than most other channels. To access the service, you must have paid the installments for the last 12 months in full and on time.

The federal housing administration mortgage program offers three refinancing options.

Simple Refinance

The FHA can allow you to refinance your current loan into a fixed rate loan or an adjustable rate mortgage. It’s an excellent option for refinancing mortgages with bad credit since it does not involve credit checks.  Furthermore, there is no income verification and home appraisal.

The simple refinance is ideal when you have considerable equity in your home. It’s also favorable for individuals looking for affordable refinancing with low-interest rates. If you want to move to a fixed rate mortgage loan, consider simple refinancing with FHA.

Streamline Refinance Program

The FHA streamline refinance program applies to people who made payments on time for the past year. They can access mortgage refinancing at a lower rate and reduced monthly payments.

It’s one of the best methods of refinancing mortgages with bad credit for several reasons. First off, it does not screen your credit or verify your income.

Then, the FHA streamline refinance program has accommodative eligibility requirements and less paperwork than most refinancing solutions. It also ignores your debt to income ratio as long as you have a good reputation in your current FHA loan.

Streamline refinancing does not always require an appraisal. In such cases, the refinance amount is capped at the original amount of the current mortgage loan, which is the same when refinancing other installment loans as well. Finally, the program has no closing costs.

If you are about to relocate and you don’t want to incur closing costs, FHA Streamline Refinance is a great option. You can also take this route if your home’s value has not changed since you acquired it.

Cash-Out Refinance

The FHA Cash-Out Refinance is suitable for homeowners with low credit ratings. It accommodates individuals with scores as low as 580, though some lenders prefer 600 or higher.

The option may not be for you if you owe a considerable amount on your home. The maximum loan to value ratio in this program is 85 percent. In other words, your equity must be 15 percent or more.

Among the FHA refinancing options discussed, the cash-out refinance program is the only one that offers more than $500 above your refinance.

Explore FHA Refinancing Without FHA Mortgage

Even without an FHA mortgage loan, it is possible to qualify for an FHA refinance. There are several conditions to meet.

First, your equity on the home should be at least 2.25 percent. You shouldn’t have any missed or late payments over the past year. Also, you cannot have foreclosures and bankruptcies within the last three and two years respectively.

The maximum debt to income ratio when refinancing without an existing FHA mortgage is 43 percent. Some lenders can raise the bar to 50 percent based on other factors.

This refinancing plan can cover the outstanding principal on your loan. However, you cannot inflate it to spare some extra cash after refinancing.

The average credit score accepted for this refinance ranges between 680 and 690. However, many homeowners have managed to qualify with poor credit scores.

With a rating of less than 580, you need to possess from 10 percent equity in the home. The lowest allowable credit score for the program is 500.

The main shortcoming of this FHA refinancing plan is that it adds a mortgage premium to the loan per year. The rate may be 8 percent or 8.5 percent of the principal, added for 11 years or until you settle the mortgage.

Use USDA Streamline Refinance

The United States Department of Agriculture owns the USDA Streamline Refinance and the USDA Streamline-Assist Refinance programs.

Both systems are similar to the FHA Streamline Refinance program. For consideration, you must:

  • Have paid your USDA loan on time for the last six months
  • Satisfy the loan-income and credit eligibility terms of the USDA
  • Borrow a maximum of the original loan value.

The Streamline-Assist Refinance program doesn’t perform a credit check and requires no new appraisal. It also does not consider your debt to income ratio. It’s available to persons with little to no equity in their homes.

The USDA’s Non-Streamline refinancing option, on the other hand, needs an appraisal.

Request a VA Refinance

The Department of Veterans Affairs provides two refinancing options to veterans and service members. Veterans with an existing VA-backed home loan can enjoy the Interest Rate Reduction Refinance Loan (IRRRL) program. It’s an excellent choice for lowering interest.

Just like the FHA Streamline Refinance, IRRRL doesn’t involve complex documentation or the analysis of creditworthiness. A VA-approved lender finances your loan.

Although the VA doesn’t regulate the amount you can borrow, it only insures up to a particular limit. The cap varies across counties.

The VA Cash-Out Refinance system applies to VA and conventional loans. It uses the equity of the homeowner as the collateral on the new loan.

Apply for HARP

You might be eligible for the Home Affordable Refinance Program (HARP) if your mortgage loan originated before the end of May 2009. HARP was a package for homeowners with a loan to value ratio of 80 percent and above. Its purpose was to enable individuals to refinance into more manageable mortgages.

The program targets people whose arrears exceed the value of their homes or those with limited equity. It helps them to shorten the loan period and reduce their monthly installments. They can also switch between adjustable and fixed rates or enjoy lower interest than in the earlier mortgage loan.

Applicants of HARP do not have to meet a particular credit score. There is minimal paperwork and undersigning, and the closing costs are low.

Your mortgage must be under Fannie Mae or Freddie Mac to qualify for HARP. The home should either be your primary residence or a second home, or an investment building with up to four units.

You also need to be current on payments. Lastly, you must meet the loan to value ratio as well as the cutoff date of loan origination.

Take a Portfolio Loan

A portfolio loan is another possibility of refinancing mortgages with bad credit. These are private mortgage loans that lenders cannot sell to Fannie Mae or Freddie Mac. Financers decide on the terms and underwriting.

For this reason, the conditions vary from a lender to another. There is no standard way of addressing credit score, income, employment, late payments, bankruptcy, and so forth.

To access portfolio loans, you may have to visit mortgage lenders or brokers who can link you with lenders. Most mortgage brokers work with multiple private lenders.

Exclude the Bad Credit Partner

For mortgages that involve two people, you can take off the bad-credit partner when applying for the loan. The person with good credit must qualify for refinancing with his or her income.

In this case, you need to change the name of the mortgage without interfering with ownership. Ensure that the names of both parties remain on the deed.

A real estate lawyer and a family law attorney can help to address insurance matters and eventualities. Significant paperwork is necessary as you may need documents like post-nuptial agreements and wills.

Refinancing Mortgages with Bad Credit – Final Word

Refinancing mortgages with bad credit is a great way to offset home loans in a more bearable way. If you can get lower interest and reduced monthly payments, you can shrink the entire mortgage substantially.

However, a refinance does not guarantee savings all the time. Most conventional lenders will take you through a process similar to acquiring your initial mortgage. You may have to pay several closing costs including application fee, appraisal, and attorney charges.

It’s vital to calculate the duration required to recover the added costs before joining a refinancing program. The costs may not make economic sense if you won’t be staying in the house for long. If you have problems paying the new loan, your credit score can decline further.

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