Refinancing: Credit Scores can Make or Break You

With mortgage rates at historic lows, it’s tempting to jump on the refinancing bandwagon. It seems unlikely that homeowners will get another chance to take advantage of such desirable rates in their lifetimes. Sure the refinancing climate is challenging, because banks are being very selective as to who will receive funds at these rates. But even a great candidate who has outstanding qualifications -- like a steady job, low debt-to income ratio, high equity in a home, and significant cash reserves in the bank -- can be turned away based on one factor alone – a less-than-stellar credit score.

Americans in refinancing dumps

Credit scores are the largest obstacles to getting a great mortgage refinance rate. According to a recent article in the New York Times, once the minimum loan criterion is set, it’s set in stone. In other words, if the bank says that you need to have a credit score of 700 to qualify for a mortgage refinance, you’ll be turned away if your score is 699. Period.

According to recent data from FICO, the credit reporting agency, more than 43 million people – one quarter of Americans have credit scores below 600. That means that those 43 million people won’t qualify for a conventional refinance with Fannie Mae and Freddie Mac, because those agencies only buy loans of people whose credit scores are higher than 620. Not only that, but the Federal Housing Administration (FHA) – which was often the mortgage lender of last resort -- will no longer offer their 3.5 percent down payment loans to borrowers with credit scores under 580.

Credit agencies aren’t helping the matter, either, because each of the big three – Experian, Equifax, and TransUnion – collect their information from different sources. Therefore, each agency has their own score for every individual, and they’re not always in sync.  If two agencies have different numbers, the bank will take the lowest score. If three report, they’ll take the middle score. If one agency says John Smith has a score of 710 and would qualify for a great mortgage refinance rate, and another agency reports his score at 625, John Smith is out of luck, because the bank will use the lower score to decide whether to grant his loan.

Cleaning up your score

If you’re looking to refinance your mortgage, the first step is to make sure that your credit score is as high as possible. First, contact all three agencies, and get copies of your reports. Check each one carefully for errors.  If you find any – and you likely will, because more than three-quarters of these reports are reported to have mistakes – contact the agency immediately to have them corrected.

Pay down any outstanding high balances on your credit cards. By lowering your debt-credit-ratio, you’ll push up your score. Finally, don’t open any new lines of credit. Your FICO score will drop each time you do.

Opportunity knocks very rarely. If you clean up your credit score, you’ll be able to take advantage of low mortgage refinance rates, and turn that once-in-a-lifetime opportunity into reality.