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Refinancing a Mortgage with Bad Credit

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You own your own home and somehow you are able to make ends meet. The car payments, the credit cards, the store credit, and especially the mortgage - you juggle the bills and try to stay ahead. But despite your best efforts you have missed some payments and you know that you have a bad credit rating. Still, you wonder about your home mortgage. Are you paying too high an interest rate? Could you refinance and save money? But most of all, can you refinance if you have bad credit?

The answer may be "yes", and you will have a greater chance of success if you follow these guidelines.

  1. Check your credit reports (you should do this once a year anyway). There are three companies that produce credit reports on individuals: Experian, Trans Union, and Equifax. According to federal law, you are entitled to see their reports once a year at no charge. You can learn more about this, and other rights you have by going to the website of the Federal Trade Commission and clicking on "Consumer Protection". Read the article how to get a free copy of your credit report for specific instructions on obtaining your credit report.

    Check your reports for errors. If you find an inaccuracy, federal consumer protection laws require creditors and credit bureaus to respond to a notification in writing. Send your creditor a certified letter describing the inaccuracies. Send a copy of your letter to the credit bureau. Include copies (not originals!) of any pertinent documents to prove that the report is inaccurate. If you call on the phone, back up each conversation with a certified letter summarizing the call. Send a copy to the credit bureau.

  2. Once you have identified and eliminated errors (if any) in your credit report, do some rough figuring regarding your mortgage payments. Let's say you have an 8.5% mortgage rate on a 30-year loan, and five years ago your original loan amount was $200,000. Your payments, depending upon local taxes and escrow, are $1,500 per month. You go online and you see that loan rates are as low as 6%. At first glance this sounds good! If your outstanding principal on your loan is $175,000, that's the amount you need to borrow when you refinance. A quick online calculator says that your new monthly payment could be $1,049. Perhaps it is worth it to explore refinancing even with bad credit.

  3. There will be fees. After all, a refinance is roughly the same thing as a new mortgage. Closing costs, which vary from state to state, average $2,748. This does not include taxes, escrow fees, or other governmental fees.

  4. This is the most important point: because you have bad credit, you will pay more than the lowest available mortgage rate. You will not know what the lender will offer you until the lender runs your credit report and crunches the numbers. It is possible that if your credit is very bad, the lender will offer you a deal that is worse than what you have now! In that case refinancing with bad credit is not a good idea and your best option is to wait and improve your credit score.

    The lender may offer a deal that is only slightly better than what you have now. Perhaps the lender will offer 8% when your current rate is 8.5%. At 8% your payments will be $1,284, but you will pay for the next 30 years. Right now your payments are $1,500 a month for the next 25 years. At your current rate of 8.5%, you will pay a total of $450,000 over the next 25 years. At the new rate of 8%, you will pay a total of $462,240 over the next 30 years. The important point is that the money you have paid to date is gone: you need to concern yourself with the money you will pay in the future. So, with a new 30-year mortgage at 8% you will pay for an additional five years, and during those five years you will pay a total of $77,040!

Since the US housing crisis and credit crunch took hold in 2008 it has become very difficult to refinance your mortgage if you have bad credit. The best option for refinancing if you have bad credit is probably an FHA loan. An FHA loan can be offered by any lender or broker that is licensed to sell FHA loans. They are loans that are backed by the US government and can allow people with bad credit to still have a shot at refinancing. The keys to qualifying for an FHA loan are:

  • The home that you wish to refinance must be your primary residence
  • You must meet the income requirements
  • You cannot have more than 2 late payments on your mortgage

For more information on FHA loans please visit our FHA loans page (link).

Can you refinance with bad credit? Possibly, but you need to work hard to improve your credit rating as much as possible, and you need to be very careful about doing the math on a loan offer made to you.