So you're looking to refinance your mortgage but you've got bad credit. What can you do?
First of all, don't panic. Although banks have tightened up their lending standards in recent years, it is still possible to refinance your mortgage even with a blot on your credit history. That's the good news.
The bad news is that getting a home refinance or any other loan gets progressively more expensive the lower your credit score is. So the question may not be whether you can refinance your mortgage, but if you can do so on terms that make it worthwhile.
How much will you have to pay?
- Depending on how poor your credit is, you may not be able to get a rate as low as you had hoped. A borrower with a credit score of 620 can expect to pay a rate about 1.5 percentage points higher than a borrower with perfect credit on the same loan, assuming the bank will approve them in the first place.
- A higher, but still-blemished score of around 680 may mean that you'll pay only about half a percent more than a borrower with a "perfect" score of 760 or more. Bear in mind, however, that other factors, such as the amount of home equity you have, will affect your rate as well.
- Borrowers with a credit score below 600 will generally have a tough time refinancing. There may be a few lenders that will approve them, but they can expect to pay a rate considerably higher than other homeowners.
- If your poor credit rating is due to a serious mortgage delinquency (a missed payment more than 90 days late), you likely won't be able to refinance. A loan modification may be a more realistic option. Contact your mortgage servicer (the company you send your mortgage payments to) to inquire about options.
- However, if your poor credit is due to lesser factors, such as an occasional late car payment or high levels of credit card debt, and you're currently paying a high rate on your mortgage, you may still be able to refinance even if you don't qualify for the lowest rates available.
Should you refinance?
Even if you can't qualify for the lowest mortgage rates, it may still be worthwhile to refinance if you're currently paying an unusually high rate. The general rule of thumb is you want to be able to reduce your rate by a full percentage point to make refinancing worthwhile, though a smaller reduction can work if you plan to be in the home a long time.
It also makes sense to refinance if you have an ARM that's about to reset to a higher rate or require a balloon payment.. Because interest rates are currently low, it isn't likely that a regular ARM will reset to a significantly higher rate right now. But if you have an interest-only or option-ARM, you could end up with dramatically higher payments if you don't refinance.
Get rates from multiple lenders
The key to refinancing with bad credit - or any time you're looking for a mortgage, in fact - is to shop around. Different lenders and brokers cater to different parts of the market, and some of them specialize in loans to people with weak credit. And it doesn't cost anything to shop around.
Obtain your credit score (more on that below) and contact 6-10 lenders and see what sort of terms they offer. Include several mortgage brokers in your list - brokers don't actually make loans themselves, but work with a variety of lenders to find the best rate and mortgage terms for you. It may take some digging to find them, because their web sites and advertising can be very similar to those of actual lenders.
Brokers are useful because they know which lenders are willing to work with bad credit borrowers. It's true that they get paid a small slice of every mortgage they help originate, but because lenders offer them discounted terms, it usually evens out in the end for the borrower.
It won't hurt your credit score to shop around with a bunch of different lenders. Credit reporting agencies recognize that people may inquire at multiple lenders when shopping for a loan and don't mark down scores for multiple credit inquiries if they occur in a short period of time, say a month or two.
Fixing your credit score
- If you've got bad credit, the best way to qualify for a mortgage is to try to improve it. There are two ways to do that: by improving your credit record and correcting any errors there may be in your credit reports.
- The quickest way is to correct any errors in your credit reports. By law, you're entitled to a free copy of your credit report each year from each of the three major credit reporting agencies - Experian, Equifax and Transunion. You can order them through the official web site, http://www.myfico.com.
- Once you have your credit reports, check them for any errors regarding your payment history on the credit accounts listed. If you find one, contact the credit agency that produced the report to inform them of the error. Be prepared to show the report is in error by submitting copies of your own payment records.
- To improve your credit history, the main thing is to make a habit of paying your bills on time. However, many people are surprised to learn that they can improve their score dramatically within 30 days simply by paying off high-balance credit cards.
- If your balance exceeds 25 percent of your credit limit on any card, it's going to hurt your credit score. If you have savings or other resources you can draw on to pay down revolving debts, it might make sense to do so if refinancing would provide a significant economic benefit for you.
About your FICO score
While you're checking your credit reports, you might want to go ahead and obtain your FICO credit score from at least one credit reporting agency. . Note that while you're entitled to obtain a free copy of your credit report every year, you normally have to pay to obtain your actual FICO credit score. You can get your Transunion or Equifax score for $20; Experian does not provide FICO scores directly.
You can sometimes get a "free" FICO score by subscribing to a credit reporting service, but since you're paying for that, it isn't really free. The credit reporting agencies will often include a credit score with your free credit report, but be aware that won't be a FICO score, which is the one mortgage lenders typically use.
The nice thing about having your actual FICO credit score (though it may vary somewhat among the three agencies) is that it lets you know just where you stand in terms of credit. That way, you have a better idea of what your chances are of refinancing, what sort of rate you may have to pay, or how much you need to improve your score to get a better rate.