7 mortgage refinance options for people with bad credit

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Can you refinance your mortgage with bad credit? The answer is yes for many borrowers. From programs backed by the federal government and private-sector options to co-signing with a stronger borrower, here’s how to refinance your mortgage with bad credit.

1. Try your own lender first

Lenders talk a lot about “relationships,” but borrowers should think about relationships also. It’s handy to have a friendly source of cash when you need financing for a home, vehicle or business, so getting to know your lender is a good idea.

“First, get a referral to a specific person at a bank,” says Leslie Tayne, a financial debt resolution attorney and author of “Life & Debt.” “Having the name of someone and something in common like the referral source is an excellent way to start building the relationship. Explain your needs and find out the options the bank can offer to you.”

What you really want is the benefit of the doubt. If a lender looks at your debt-to-income ratio (DTI) and your loan-to-value ratio (LTV), as well as other factors, and your application is in a gray zone, it can go either way. You want a “yes” — and if you have a relationship with the lender, then maybe you’ll also have a helpful edge.

“Communicate often and be prepared with the [financials] the bank will be requesting to back up your request for funding,” says Tayne. “Being organized and responsive is vital. The banker will appreciate you helping him/her do their job better, which is to put the loan together for underwriting.”

2. Try FHA’s Streamline Refinance

Almost two-thirds of FHA borrowers had scores below 679 in 2019. If you have bad credit and an existing FHA loan, consider the FHA Streamline Refinance program. With this program:

  • You can get today’s refinance rates.
  • You don’t need a lot of new paperwork, since you already have an FHA-backed loan. With an FHA Streamline Refinance, the lender is generally not required to verify income, run a credit check or demand a high-cost appraisal. What the lender must have is evidence that the most recent six consecutive monthly payments were on-time and paid in full. The borrower must be current with the existing loan.
  • When your current FHA loan was originated, the government charged an upfront mortgage insurance premium. By refinancing within three years. you may be able to get some of that upfront money back. The refund can be used to offset the new loan’s cost.
  • The government requires that the refinance produce a “net tangible benefit” for the borrower, such as a 5 percent reduction in the monthly cost for principal and interest or a change from adjustable-rate financing to a fixed-rate loan.

It’s also important to understand that FHA Streamline Refinance loans aren’t cash-out refinancing programs. The main benefit of this loan option is to permanently lower your monthly payments.

3. Check out an FHA rate-and-term refinance

The FHA Streamline Refinance program is reserved for current FHA borrowers; however, any borrower with a high interest rate may be able to benefit from an FHA rate-and-term refinance.

A rate-and-term refinance is generally designed to help borrowers refinance prime residences. A new appraisal and credit check are required as part of this refinance, and to qualify, you need to demonstrate six consecutive monthly payments that are on time and paid in full.

This is not a cash-out refinance program — the purpose is to help you reduce your monthly housing costs — and all proceeds must be used to pay your existing mortgage and costs associated with the transaction.

However, the program has some important, if surprising, uses. For instance, an FHA rate-and-term refinance can be used to pay off land contracts, a form of installment financing. Also, if you’re getting divorced, an FHA rate-and-term refinance can be used to refinance a current mortgage and originate a new loan without the co-borrower.

4. Apply for a VA refinance, if eligible

If you’re VA-qualified, you can refinance an existing VA mortgage with the no-hassle Interest Rate Reduction Refinance Loan (IRRRL), which typically does not require a credit score or appraisal.

VA loans are especially attractive because you can refinance up to 100 percent of the property’s value. As with all VA programs, there’s an upfront funding fee for most borrowers, and the fee can be added to the loan amount. However, with VA financing, there is no annual cost to guarantee the loan.

“The VA has updated IRRRL guidelines in recent years, with a focus on ensuring the refinance makes financial sense for qualifying veterans,” says Chris Birk, director of education at Veterans United Home Loans. “Homeowners will need a minimum amount of ‘seasoning’ on their current loan in order to be eligible for an IRRRL. That typically means you must have made at least six monthly mortgage payments, although some lenders have even more stringent seasoning guidelines.”

The VA will not permit refinancing with excessive costs, and as part of its effort to ensure every loan produces a “net tangible benefit” for the borrower, it wants to see a clear rate reduction.

“VA homeowners must be able to recoup the costs of the new loan within 36 months of closing,” says Birk, author of “The Book on VA Loans.” “Those costs do not include the VA funding fee or escrows.”

Birk also explains that the “minimum basis point reductions vary depending on whether you’re refinancing into a fixed- or an adjustable-rate loan. For example, a VA homeowner refinancing a fixed-rate loan into a new fixed-rate loan would need to see their note rate reduced by at least 50 basis points.”

Those wishing to pursue an IRRRL won’t go directly through the VA, but rather through a private bank, mortgage company or credit union.

5. Consider a portfolio refinance loan

Another refinance option if you have bad credit is what’s often called a “portfolio loan.” You can obtain a portfolio loan — so called because it can’t be sold on the secondary market, and is instead held by the lender — through banks and mortgage brokers, who set their own standards for the loan.

While portfolio loan standards may differ from typical loan requirements, that does not mean lenders will finance any borrower regardless of qualifications. They still want portfolio loans to perform, and that means there will be a careful look at the borrower’s finances and credit history.

But, if there’s been a nagging application issue that will not pass muster with most lenders, a portfolio lender may be more open to your application.

“Lenders’ customer bases can vary depending on their customer’s target market,” says Tayne. “Some cater to smaller borrowers because it’s their specialty or primary customer base, and they’re looking to build their portfolios of small lending. Smaller borrowers typically have the potential for growth, and the more money a business is making, the more money the lender is making.”

To find out about these loans, work with a mortgage broker or a full-service mortgage lender who can shop your potential refinance loan to portfolio lenders.

6. Find a co-signer

If bad credit is preventing you from getting a better mortgage, there is one strategy that can quickly change your situation: getting a co-signer.

A co-signer with strong credit and deeper pockets gives the lender more security. If the loan is not repaid, the co-signer is responsible, and the lender can look to them for any shortfall.

Even among family or friends, co-signing a mortgage is a business deal. Strong co-signers worked to get their money and credit, so you will have to convince them that you have the financial capacity to repay the loan, and that you will put repayment of the loan first, before other obligations.

Some difficult questions will also have to be answered. Is the co-signer also a co-owner of the property? What happens in the event of divorce, death or a simple falling-out? Both parties should have wills, living wills and any other paperwork needed to protect estates. Get help from an attorney to get the entire arrangement in writing, to protect both yourself and your co-signer.

7. Work to improve your finances and credit

Bad credit is not permanent — it can be changed. If none of the above options work for you, it may be a good idea to take a step back and evaluate your overall financial situation. Your first steps:

Start a budget – Track the money you take in and the money that goes out. When you start a budget, you may find ways to reduce expenses. Understand that little expenses add up.

Check your credit report – At AnnualCreditReport.com, you can check your credit reports from the three credit reporting bureaus weekly, for free, until April 20, 2021. Look for factual errors, unauthorized charges and fraud. Credit report issues can lead to lower credit scores and higher financing costs.

Pay down bills – Try this strategy: Make a list of all debts and arrange them by size. Target the smallest debt and pay it off. By doing this, you’ll have one less bill to pay, and you don’t have to worry about late fees, since it’s paid off. The money saved each month can then be used to pay down the next bill you tackle.

Save – Help yourself, no matter how small. If you put aside $8 a week — maybe from the change you get each day —you’ll have $416 at the end of a year. Once you get into the habit of saving, you will likely find it gets easier with each dollar you stash away.

Featured image by Jumping Rocks of Getty Images.

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