Refinancing your mortgage can save you hundreds of dollars a month and potentially tens of thousands of dollars over the life of a standard 30-year home loan.
If you’re nervously watching interest rates rise, and are thinking about refinancing your home, you may have been sitting on the sidelines because you’re worried about your credit. While refinancing a mortgage is no doubt tougher to accomplish when your credit is so-so, or even bad, you can nevertheless get a refi done. Here are five tips to help you refinance your home loan, even if you have blemishes on your credit report.
Tip #1: Don’t Expect Ultra Low Interest Rates
You’ve no doubt seen mortgage advertisements online, in newspapers, or on radio and TV offering homeowners rock-bottom interest rates – sometimes as low as 3% to 4%%.
Well, good luck actually getting a loan at those very low rates, despite all those ads.
According to BankRate.com, as of July 29, the average 30-year fixed rate mortgage was 4.38%. So if you were hoping for record low interest rates in the sub-4% range, those days have passed.
Rates have been rising in recent weeks – especially after the Federal Reserve Bank announced in July that it would stop buying back bonds, a move that had been keeping interest rates artificially low.
There’s another reason, though, that some people shouldn’t be fooled into thinking they’ll get those “teaser” rates that lenders often advertise: It’s that the very best, low interest rate mortgages are reserved for pristine borrowers.
So if your credit is shaky, you can refinance – but just not at the cheapest loan rates available in the marketplace.
Tip #2: You typically need to have equity in your property
In the current environment, most lenders will generally not refinance your existing mortgage if your home is underwater and you owe more on the property than it’s worth.
Even if you’re not underwater, some banks won’t even want to refinance your current mortgage if you only have a little bit of equity in your house.
The reason banks shy away from refinancing properties with little equity is because the new home loan is made based on the current market value of your property.
Without much equity, your loan is seen as “riskier” – and that reduces many lenders’ willingness to issue you a new mortgage.
Also, the more conservative the bank, the greater the amount of equity they will want you to have. For example: very conservative lenders may want you to have 25% to 30% equity in your home for a refi. In other words, they want your loan-to-value or LTV ratio to be 70% to 75%.
In dollar terms, a 75% loan-to-value mortgage means that a lender is willing to lend $300,000 on a property worth $400,000.
Middle-of-the-road lenders will do mortgages with an 80% to 90% loan-to-value.
And aggressive lenders will offer mortgages with a 95% or higher loan-to-value.
Tip #3: Consider Government Insured Loans
All isn’t lost, though, if you don’t have sufficient equity in your home. You can get around that problem, and still get a refinance done.
That’s because lenders doing conventional mortgages are the ones that insist on lots of equity in your property. But that’s not the case for banks offering government-backed loans such as FHA loans, that are insured by agencies like the Department of Housing and Urban Development (HUD).
To refinance a mortgage with an FHA loan, you can have a tiny amount of equity and still get a new mortgage with a LTV limit of 97.75%. So let’s say your property is worth $250,000. With an FHA loan, you can refinance and get a loan up to $244,375, or 97.75% of your home’s value.
Tip #4: Seek an FHA Streamline Refinance
Additionally, if you already have an FHA loan, it’s worth seeking an FHA streamline refinance, which is a special mortgage product reserved only for current FHA borrowers.
For those loan applicants who might not be ideal borrowers on paper, for one reason or another, the FHA streamline refinance has a lot going for it.
For starters, an FHA streamline refinance does not require an appraisal. So right off the bat, you can still qualify for this loan even if you have no equity or your home is underwater.
Even better, from a borrower’s perspective, is that the FHA streamline refinance is easier to qualify for because the loan does not make you verify job, income or credit.
Tip #5: Make the rest of your application attractive
Bad credit alone doesn’t have to prevent you from getting a home loan refinanced. But if the rest of your loan packet is questionable, then you could be in trouble.
So try to offset any bad credit, by making the rest of your mortgage application as pristine as possible – especially if you’re seeking a conventional loan.
Gather all your job paperwork (such as W-2 statements and paystubs) and be able to document your income. Also, if you’ve been gainfully employed for a long period, stress the length of time you’ve been on your job. If you have a raise coming up later this year, or early in 2014, get a letter from your boss to this effect, if possible. That will further show job stability to a lender.
Finally, provide bank records that demonstrate proof of savings. Having cash reserves in the bank can also make your overall loan application more attractive to a lender.
In the end, if you package your application properly, and position yourself in the best possible light, you’ll discover that you can get a refinance done – even if you have bad credit or average credit.
Lynnette Khalfani-Cox is a personal finance expert and co-founder of the free financial advice site, AskTheMoneyCoach.com. Follow Lynnette on Twitter @themoneycoach.
