by Tom Murphy
NMLS # 662141
Home Services Lending
If you have average to poor credit, getting your credit score up is extremely important. In some cases, if your score is too low, you will have difficulty refinancing your mortgage. However, if you have at least a 640 credit score, you may be able to refinance your mortgage, and doing so can help to get your credit history on the right track again.
If you have a VA loan, you are in luck: You can do a streamline VA refinance and they usually do not even do a credit check before you apply for the loan at all. So you may be able to easily refinance a VA mortgage whatever your credit score. Also, some FHA lenders may not verify your credit with an FHA streamline refinance, but some will.
But if you have a conventional loan, a refinance can help to build your credit, as long as you make your payments on time. Here’s why:
#1 Diversifies Credit
There are five basic things that make up your credit score:
- Payment history
- How much you owe
- How long your credit history is
- Types of credit
- Any new credit
A factor in how high your score is will be the mix of credit that you have. Lenders like to see a variety of credit being used on your profile. For example, a lender might like to see that you have two revolving credit accounts that you mostly pay off each month, and having an installment loan is also a good sign, if you are paying it on time.
Installment loans include bad credit mortgages and car payments. These are fixed payment obligations over a long period of time. So if the creditor sees that you are paying a long term debt reliably, this can show that you are a reasonable risk. Getting a refinanced mortgage can help to diversify your credit, so in the long run, it can help your score.
#2 It’s Big, But It’s Good
Your mortgage is probably the largest debt you have on your credit report, but debt is not always bad. Creditors usually consider it to be good debt, if you are making payments on time. Unlike your credit card, you have a physical asset backing the loan: the house. If you fail to make payments, the lender can take the home within 90 days or so. For that reason, bad-credit mortgages are fairly safe investments for lenders. Also, taking on a bad credit refinance mortgage indicates that you are a responsible borrower; again, you are (hopefully!) paying your mortgage regularly each month. It being a long term obligation that you are paying regularly will boost your score.
#3 You Can Build Your Payment History
The most important part of your credit score is your payment history. Mortgages almost always require 15 or 30 years’ worth of payments. If you are making your payments on time over a long period, your score will definitely rise as the years pass. But all it takes is one or two late payments more than 30 days late for your score to drop again. In most cases, your credit report will show your past two year payment history, so you do not want to have any late payments ever, but especially not in the last two years. So make certain you are paying your refinanced mortgage on time!
While getting a refinance mortgage can improve your credit score in the long run, you should know that it also can drop your score in the short run. As soon as you take out a mortgage, you probably will see a score decrease. However, if you simply make your payments on time, you should see your score steadily rise.
And as long as you are making payments on a timely basis for the next few years, you will see your score go higher, probably higher than it has ever been. It is not unusual for a person with a mortgage for 10 years with no late payments to have an 800 FICO or higher.
Another thing to consider is that if your credit is so-so when you are applying for a refinance, you may have to pay a higher interest rate. This could mean that refinancing could cost you more in monthly payments. If so, you might weigh delaying your refinance and getting your score up first. Here are some easy ways to do it:
- Pay off credit cards. If you are able to pay off a several thousand dollar credit line, you will see an almost immediate jump in your credit score. In some cases, it could be as much as 40 points. So if you have the cash, try to pay off as many cards as you can before applying for a refinance.
- Do not open a bunch of new credit lines right before you apply for a bad credit refinance. The lender might think you are desperate for money and may not want to give you a mortgage.
- Never close old credit card accounts that are in good standing. Many people do this thinking that an unused credit line hurts your score. Wrong! In reality, an open credit line in good standing, especially an older one, is GOOD for your score. The problem is when you close it; you have just reduced your available credit by, in some cases, many thousands of dollars. This will nearly always drop your score.
For many people, refinancing a mortgage can lead you to increasing your credit score – in the long run. But in the short run, it may drop your score. The good news is, as long as you are paying that debt on time each month, your score will do nothing but go up in the coming years. So, you should definitely look at refinancing a mortgage, if your score is high enough for you to refinance at a reasonable interest rate.