You want to refinance your mortgage, but you have bad credit. Are you stuck with your current loan? Luckily, you have options. Lenders don’t base their decision entirely on your credit score. They look at other qualifying factors as well. Don’t worry, you aren’t stuck paying high interest rates just because your credit score is less than perfect.
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The key to mortgage approval with a low interest rate is to maximize your qualifying factors. Your low credit score is only one piece of the puzzle. Work on the other pieces to make them as attractive as possible if you can’t raise your credit score in time for a refinance.
Stabilize Your Income
Outside of your credit score, your income is the next most important factor when refinancing and trying to get a low interest rate. Lenders need to know that you have enough income to cover the new payment. You also need enough income to cover your other monthly expenses.
stable your income, the less risk you pose. The best-case scenario is to have a job that you have held for many years along with steadily increasing income. If you can show higher gross monthly income from year-to-year, you show a lender that you are not high risk. They may even use this as a compensating factor for your bad credit.
This isn’t to say you cannot change jobs and expect to refinance. You can, you just may want to wait until you are at the job for at least 12 months before you try refinancing. The longer history you have at a job, the less risk you pose to a lender.
Reserves are also another great compensating factor when you have bad credit. Reserves are money you have available should your income stop or decrease. The money must be in a liquid account, such as a savings account, CD, or other investment that can be liquidated quickly. It cannot be in other real estate or cars, for example. You cannot access those funds right away.
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Lenders look at your reserves based on how many mortgage payments it can cover. For example, if you have $5,000 in reserves and your total mortgage payment is $1,000, you have 5 months of reserves available. Lenders don’t set a minimum amount of reserves you must have; but the more you have the lower interest rate a lender may offer. Aim to save between six and twelve months’ of your mortgage payment for the best results.
Apply for an FHA Loan With Bad Credit
FHA loans are among the most flexible programs with the lowest rates available. You only need a 580 credit score and a
debt ratio of 31/43. Of course, different lenders have different requirements, though. Just because they offer the FHA program doesn’t mean they will definitely accept a credit score of 580 and a total debt ratio of 41%. Each lender has their own requirements.
It’s best if you have at least one qualifying factor that is attractive. For example, if you have a low credit score, try lowering your debt ratio. This gives the lender less risk with your debt ratio, but higher risk with your credit score. Having a low credit score and high debt ratio is a double risk for the lender and may cause them to turn you down. If they don’t turn you down, they may charge you a higher interest rate.
FHA interest rates in general, however, are usually pretty competitive with conforming loans. This helps you save the most money on your refinance, but make sure you take the mortgage insurance into consideration. The FHA requires mortgage insurance on every loan for its entire term, not just until you owe less than 80% of the value of the home.
Keep Up the Compensating Factors
If you apply for a loan outside of the FHA loan, make sure you focus on those compensating factors. If you don’t have the time to better your credit score, consider increasing your other factors. A good debt ratio or a lot of reserves on hand can go a long way in convincing a lender to give you a loan with a low rate despite
your bad credit.
It also helps if you have an explanation for your poor credit. Was it a one-time occurrence that caused you to get in over your head? Maybe you fell ill or lost your job. These things can cause you to be unable to pay your bills. If you were able to rectify the situation quickly and get back on your feet, it shows the lender that despite your fall, you are able to get back up. This too can serve as a compensating factor, helping the lender give you that refinance that you need.
Your bad credit doesn’t have to derail your refinance efforts. Figure out how you can improve your application to make you look as attractive as possible for a lender. This way you’ll still be able to secure a good interest rate and refinance your loan as you wish.
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