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Bad Credit Refinance Loans - A Thing of the Past?

by Brandon Cornett, 10/18/08

Right now, hundreds of thousands of people in the U.S. are trying to refinance their home mortgage loans. The mortgage crisis has scared a lot of people away from ARM loans and other high-interest situations, so there is a rise in refinancing rates. But many of the people trying to refinance have bad credit scores, which creates another situation entirely.

For far too long, consumers have been lied to about bad credit mortgages. Greedy lenders offered low "teaser" rates and downplayed the risks of future rate increases. This is number-one factor that led to the subprime mortgage crisis in this country. As a result of this mess, it's much harder to get financing when you have credit problems today — and that goes for bad credit refinance loans as well.

Mortgage lenders today are increasingly nervous about making loans to those with poor credit. And why wouldn't they be? It's harder to sell these loans on the secondary mortgage market these days, which is what they've always done in the past. There are also tougher regulations on subprime lending practices. So that's your first obstacle when trying to refinance with a bad credit score. Very few lenders will be willing to help.

But there's another big reason I urge caution to people who are refinancing under these conditions. In most cases, it just doesn't make sense to refinance a home loan when you have bad credit.

Refinancing With Bad Credit - Rarely a Good Idea

The first thing you have to ask yourself is this. "Does it even make sense to pursue a refi right now, in light of my credit status?" Like all financial matters, this is a question that must be answered on an individual basis. Generally speaking, however, bad credit refinancing is rarely a good idea. It's easy for me to say this, because I do not work for a lender. So you can trust my opinion as being objective and unbiased.In order to understand why it's usually a bad idea, we have to examine the primary reasons that people refinance their homes in the first place.

The vast majority of people who use mortgage refinancing do so to secure a lower interest rate on their home loan. When done properly, this can save you money over the life of the new loan. There are two ways to secure a lower rate on your refinance loan — you can (A) improve your credit score to qualify for better rates, or (B) take advantage of a decline in the prime interest rate. Or, of course, a combination of these factors.

You can see where this is headed. If you are trying to refinance with bad credit score you have taken one of these factors out of the equation. So the chances of refinancing successfully, by saving money over the long-term, have dropped significantly. Remember, the key to a successful refi is to get a lower rate on the new loan — low enough that the money you save exceeds the money you pay to refinance (closing costs). But there's one thing you can be sure of here. A bad credit score is going to prevent you from getting the best rate on the new loan. So when you do the math, you may find out that you are going to pay more in the long run by refinancing the loan.

But all of this assumes that you can get approved for a mortgage refinance with credit problems. And as we discussed earlier in this article, there's a slim chance of that happening. Subprime loans for borrowers with bad credit are nearly extinct these days — as well they should be. After all, this type of lending practice has nearly wrecked our entire economy!

Here's My Recommendation

I recommend you focus your energy on improving your credit score. You'll find plenty of advice to help you do that, right here on this website. From a mortgage lending standpoint, people with bad credit are going to be left out in the cold for a long time. So the best thing you can do is to elevate yourself out of that category altogether.

You cannot trust a mortgage lender to tell you when refinancing does or does not make sense for you. In some states, like Texas, there are laws that only allow lenders to give refinance loans when it will improve the borrowers financial situation (in other words, when it will save them money). We need more laws like this to prevent bad credit refinancing nightmares. But unfortunately, not all states have such laws. So you need to be your own advocate.

Here are some helpful resources you can start with:

Brandon Cornett is the creator of the Home Buying Institute. He created this section of the website to help people with bad credit get back on track. If you have a low credit score and are trying to improve, check out this related section of our website.