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4 Tips for Refinancing a Mortgage with Bad Credit

Refinancing your home loan can make your mortgage more affordable, but having less-than-perfect credit can be a stumbling block to approval. A negative credit history or low score can affect your ability to qualify for a refinance, as well as the kind of interest rate you’ll pay. While a refinance isn’t out of the question for homeowners with bad credit, it’ll likely be more difficult to obtain one. Use these strategies to improve your chances of getting approved… and lowering your monthly mortgage payments.

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1. Review Your Credit History

Before you start looking around for a lender, it’s important to take a close look at what’s on your report that could be dragging your credit score down. Late payments, charge-offs and collection accounts tend to do the most damage, but your score can also suffer if you have a lot of inquiries for new credit or you’ve run up high balances on your credit cards.

Once you pinpoint what’s hurting your credit, you can take steps to improve it. Paying down your balances, settling up on old accounts and making sure everything gets paid on time going forward can help to increase your score over time. Also, there’s always the opportunity to correct any mistakes that are on your credit report.

2. Be Realistic About Your Rates

Your refinance rates could be higher than your traditional mortgage loan, depending on your circumstances.  You probably won’t be able to snag the lowest interest rate if your credit isn’t that great. Understanding what kind of rate you’re likely to qualify for can help you decide if refinancing is even worth it.

As a general rule of thumb, refinancing typically doesn’t pay off unless you’re able to drop your rate by at least one full percentage point. If you’re only able to shave a half or quarter point off because of your credit, you’re likely going to be better off waiting for your score to improve before applying for a loan. This is mostly because of the closing costs you will pay (either upfront or spread out over the course of the loan).

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If you currently have an interest-only adjustable rate mortgage, you might be concerned about the rate resetting to a higher level in the near future. In that scenario, you might benefit from transitioning to a fixed-rate mortgage even if the immediate reduction in your interest rate is less than a point.

3. Opt for an FHA Streamline Refinance

If your original mortgage loan is backed by the Federal Housing Administration, you may be able to get around your bad credit by applying for an FHA Streamline Refinance. This kind of loan doesn’t require an appraisal – which can be a plus if you haven’t built up any equity in the home – and you’re not subject to verification of your work history, income or credit.

To qualify for this kind of refinance, you have to have at least a three month history of paying your current mortgage on time and your loan must be current at the time of closing. You can’t use a streamline refinance to pull equity out of your home and you can’t build the closing costs into this kind of loan (by spreading them out over the course of the loan). Any origination charges, escrow fees or other costs have to be paid when the loan is finalized or credited by the lender.

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4. Play Up the Positives

Besides your credit, lenders will also be looking at your income, assets and liabilities when making a final decision on a refinance loan. Doing what you can to make the rest of your financial outlook as attractive as possible can help to offset what your credit is lacking.

Making sure you’ve got all of your income statements, bank statements and tax forms together is a good place to start. Keeping your debts to a minimum and building up your cash savings can also add to your appeal.

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Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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