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Mortgage rates have recently hit record lows, and many Americans are jumping at the opportunity to buy new homes as well as refinance.
According to the Mortgage Banking Association (MBA), mortgage applications have been surging since March 2020 when the Fed slashed interest rates in response to the coronavirus pandemic. By year-end, mortgage applications are expected to double in volume compared to economists' original 2020 predictions.
Mortgage refinancing applications are also on the rise: Currently, Americans are applying for refinancing loans at a 38% higher rate than they were this time last year.
Refinancing your house means essentially taking out a brand new loan, often for the remainder that you owe on the property (but not always). Depending on how much equity you have in the house (i.e. what you've paid on it already) and what your credit score is when applying, refinancing might offer you one or more benefits, including:
- a lower interest rate (APR)
- a lower monthly payment
- a shorter payoff term
- the ability to cash out your equity for other uses
When you're faced with economic uncertainty, refinancing your mortgage can help give you some breathing room. But at the same time, if you're struggling financially, refinancing can be a little more complicated. If you have a bad credit score, you'll need to take a few steps to ensure you can even qualify. And when you do qualify, you want to make sure your refinanced mortgage is better than your original mortgage, not worse.
Below, CNBC Select spoke with senior community development loan officer at Quontic Bank Darrin Q. English about what to keep in mind while refinancing your home with less-than-perfect credit. He shares 3 tips to keep in mind.
- Understand what "bad credit" means to banks
- Work with a community loan officer
- Improve your credit
The first step in refinancing your mortgage is to understand what banks are looking for in order to give borrowers the best rates.
The minimum credit score you need to be eligible for the most accessible mortgage programs, such as the Federal Housing Authority (FHA) loans for first-time homebuyers, is 580 (sometimes as low as 500, depending on your down payment).
But for refinancing, you want a better score than 580, says English.
"There is no desire right now to lend to subprime candidates," he tells CNBC Select. English defines such candidates as having a score below 580 and at least two missed payments on their credit report — especially on an installment loan in the past 12 months.
Those requirements make sense. Refinancing, or refi, loans are meant to give borrowers with positive credit history a chance to leverage their creditworthiness and compel lenders to compete for their business. People normally refinance after they've built a good track record and built up equity in their home. When banks see this, they'll think of you as less of a risk and will be more likely to give you a better loan with good rates.
"When it comes to refinancing, 620 is the minimum number that you really need to have in order to be able to leverage one lender against another," says English. Hitting this mark opens up more access to loan programs and gives you the chance to shop around. And the real "sweet spot," says English, is 680 or above.
Loan officers who have expertise in community development can be your number-one resource when you want to refinance your home. You can get a long way with researching mortgage programs on the web, but loan officers can serve as a partner and help you identify, then work toward, your options.
In addition, loan officers have access to industry tools that might be able to put you on the fast-track toward becoming eligible for a mortgage. Often, a loan officer can look at your credit report and identify actions you can take to improve your credit within 30 days or so. They might suggest that you pay down certain balances or flag errors on your report and offer advice on how you can resolve them.
Once you've taken steps to improve your credit, a loan officer can also do something called a "rapid rescore" and submit proof of your new, improved credit behavior directly to the credit bureaus.
"We have the ability to have the bureaus refresh the borrower's credit and reevaluate them based on new balances and other updates. [The bureaus] use some form of artificial intelligence to determine risk, and they'll score the borrower's new credit based upon that," says English.
Community loan officers can also help you understand the ins and outs of every mortgage program so you're comfortable with the terms of your loan.
Once you understand what the banks are looking for in a borrower, and you've formed a relationship with a trusted loan officer, use a credit monitoring tool to monitor your credit while you work to rebuild.
English recommends using free credit score simulator tool like the one from CreditWise® from Capital One. Similar to what the credit bureaus see, you can check the status of all your credit accounts and see the potential effect that certain actions, like paying off debt or closing a credit card, may have on your credit score. Start checking your credit score a few months before you know you want to refinance, so you know ahead of time what improvements you might need to make.
Credit bureaus monitored
TransUnion and Experian
Credit scoring model used
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The credit bureau Experian also offers a free credit monitoring service that you can sign up for without providing a credit card number. It is helpful to pull your report with a credit bureau in addition to using simulator tools like Capital One's CreditWise, since mortgage lenders look at the same reports when evaluating your creditworthiness.
"A bank will use all three bureaus," says English. "It's called a tri-merge credit report, which includes Experian, Equifax and TransUnion. Then we'll use the middle, or median, score as the qualifying credit score."
Credit bureaus monitored
Credit scoring model used
Dark web scan
Yes, one-time only
English also recommends that you take advantage of Experian Boost™, which lets you add positive payments for phone and utility bills to your Experian credit file, potentially increasing your credit score. Experian Boost now lets you add on-time Netflix payments to raise your credit score.