- Paying Your Mortgage
How to Refinance With Bad Credit?
With interest rates near historic lows, it’s no wonder so many people are considering refinancing their homes mortgage and replacing their existing mortgage loans with a new, lower rate loans. This can save homeowners money over the life of the loan (they’re paying less in interest) and lower their monthly payments. But for homeowners with less-than-stellar credit, refinancing at a good interest rate — or at all — can be difficult. This guide will help.
How Does My Credit History Impact Refinancing?
Lenders use your credit score to determine how likely it is that you will pay them back in full and on time. Credit scores range from 300, which is very poor, to 850, which is perfect. Your score is calculated by looking at your past payment history (35 percent), amount owed (30 percent), length of time you’ve had credit (15 percent), new credit (10 percent) and type of credit (10 percent).
As you can see, the bulk of your score is based on your past payment history and total debt, so people with too much debt or who haven’t paid their bills on time are going to seem “high risk” to lenders. Thus, a mortgage lender will charge a person with poor credit a higher interest rate to refinance because the lender is taking more of a risk by lending that person money. So while someone with an 800 credit score might only pay 3.5 percent on their mortgage, someone with a 650 or below may pay a full percentage point or more higher, which will likely equate to paying the lender tens of thousands of dollars more in interest over the life of the loan.
If you have poor credit and want to refinance, it’s important to calculate your monthly payments and to make sure a refinance is right for you. When you factor in closing costs and fees, the new loan, even if it is a slightly lower rate than your current loan, may not make financial sense. Beware: Sometimes, a refinance will lower your monthly payments (it’s lowering your interest rate) but will extend the term of your loan (i.e., it will make the new loan a 30-year loan even though you’d already paid down five years on your original loan and only had 25 more to go), which can end up costing you more in the long term. In this case, think long and hard about whether these lower monthly payments are worth the long-term cost.
How Can I Improve My Credit Score to Get a Better Interest Rate?
The better your credit score, the lower the interest rate a lender will likely grant you. To boost your score, first, get a copy of your credit reports (on annualcreditreport.com you get a free report each year) from all three credit bureaus (Equifax, TransUnion and Experian), and correct any errors you see on these reports that might be lowering your score. (You can learn how to correct errors on the credit bureaus’ websites.)
Going forward, pay all of your bills on time (create automatic reminders or set up automatic bill pay if you have trouble remembering to pay them), don’t take out several new credit lines at one time, and pay down your total debt load, especially if you’ve nearly maxed out all your lines of credit.
If you have extremely bad credit, you may not be able to get a credit card, which means you’ll have trouble showing lenders that going forward, you can pay your bills on time. In this case, consider getting a secured credit card. With these cards, you can only charge the amount you have deposited in an account for the lender; you don’t have to pay the card off in full each month, but if you don’t, you will be charged interest.
What Else Can I Do to Get a Lower Interest Rate?
If you’ve done everything you can to improve your credit score but still can’t refinance or get an interest rate that you want, you should take other measures to help ensure you get a lower interest rate.
First, if you can manage it, put a significant amount of money in the bank or have other liquid assets on hand, as this shows the lender that you have the means to repay the loan.
Second, consider having someone with a higher credit score than you co-sign the loan. This, too, gives the lender assurance that you will repay the loan in full and on time because now a person with good credit is also responsible for the loan. Just make sure that the co-signer understands that if you don’t repay the loan, the co-signer is on the hook for repaying it.
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