For homeowners with poor credit scores, arranging a bad credit refinance with favorable terms can be difficult. If money is necessary to cover unexpected events, look at all options available. Then, evaluate the real cost of refinancing the home before doing it.
Refinance Advantage
It is advantageous to refinance a loan if existing interest rates are high, or the loan has an adjustable rate mortgage which changes the payment from month to month. In this situation, the homeowner can benefit by getting a loan with lower interest locked in for a fixed period of time. Even if the rate drops by ½ -1%, the payment will be lower, and long term savings will be significant.
Refinancing allows equity to be pulled out of the home as well, but the larger loan amount is usually balanced out by the lower interest rate. Cash is then used for anything the homeowner desires, and many use it to pay off debts. Assuming a strong real estate market, refinancing for equity is one of the biggest advantages of home ownership. Unfortunately, with poor credit one can get equity out of the home but end up with a more expensive loan.
Refinance Disadvantage
If the loan is refinanced with higher interest, mortgage insurance or hidden points, the homeowner will pay a penalty for some time. In this situation, the only justification for refinancing with bad credit is for an emergency. The loan becomes more expensive on a monthly basis, as well as over the life of the note.
An exception would be using the equity to pay off lingering debts. The borrower pays more in the short term, but they can improve credit scores by cleaning up their credit report during this time. The result is the ability to refinance later and receive better rates. Avoid making a situation worse by properly allocating the equity; settle accounts and don’t let the increased monthly cost of the mortgage be for nothing.
Choosing to refinance with sub-par credit does not mean letting FICO scores continue to plummet. Not when the cost of a low score is considered; on average people will pay between 3-6% higher than the national rate for a home loan when their scores fall below 600. This situation does not correct itself, either. Resolve to target the negative marks on the credit report and improve your long term savings on interest.
The majority of bad credit history can be cleared up within a year or less, and can be done by the debtor themselves. Exceptions to this are bankruptcy and foreclosure, which can stay on a report for 7-10 and 3-4 years respectively. Begin by contacting the three major credit bureaus, and obtaining credit report copies from each. Scrutinize the report for incorrect information or debts which should have been discharged in a bankruptcy. Removing these trade-lines will bring a FICO score up quickly. The process of improving a score requires current credit lines to be maintained, or new lines opened to show a positive credit history.
Before starting an application for a new loan with bad credit, carefully consider each alternative. Waiting until better loan terms are available may be worth foregoing immediate cash needs.
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