If you have bad credit, you might feel like you are out of luck when it comes to refinancing. After the mortgage crisis, most banks restricted their lending to those with great credit and positive qualifying factors. Gone were the days of giving out loans to those people that had blemished credit or could not fully verify their income. Today, however, there are certain loans that you can use in order to qualify for a refinance, all of which come from the Federal Housing Authority.
FHA loans have been around for hundreds of years and have always been a helpful way for consumers to purchase or refinance a home. These loans still serve the same purpose they served when they were first originated – they help people with less than stellar credit get a loan. The people that would otherwise be disqualified for conventional financing are able to purchase and refinance their homes with FHA loans.
FHA loans are not funded by the FHA – they are still funded by the bank that provides the funds. The difference, however, is that the FHA backs the bank up in the event that you were to default on the loan. This means if the bank provided you with a loan today and a few years from now you found it impossible to make your payments and you defaulted long enough that the home went into foreclosure, that the FHA would pay the bank back. This type of “insurance policy” helps banks be slightly more liberal with the loans they hand out because their money is not completely at stake with every borrower.
Refinancing from a Conventional Loan to an FHA Loan
You do not have to have an FHA loan currently in order to refinance into one. If your credit fell as a result of the decline in the economy in the past and you want to take advantage of today’s low rates, you can apply for an FHA loan. You will have to qualify for the fully documented FHA loan, which means you need the following:
- Income documentation that includes paystubs, W-2s, and/or tax returns
- A new appraisal on the property
- A full credit report to determine your credit history and your debt ratio
If you have a credit score that is at least 580; can fully document your income and it has a stable history over the last 2 years; and the value of the property comes back high enough that your LTV does not exceed 97.5%, you are a good candidate for the FHA refinance.
Back to Work Program
The FHA does provide borrowers with a program that has some exceptions. If your credit history is rather blemished because you suffered a bankruptcy, foreclosure, or short-sale, you are not out of luck. Typically, FHA lenders want to see a solid housing history (no late payments in the last 12 months) and no more than one late payment on any other type of debt, and at least a 2-year period between your loan application and the discharge of a bankruptcy or sale of your home in foreclosure, but with the Back to Work Program, there are exceptions. This program grants exceptions to the people that can prove that they lost their home or filed for bankruptcy because of a one-time occurrence that was out of their control. These instances could include:
- Loss of a job due to the company closing or downsizing
- Sudden illness that made it impossible to work
- Sudden injury that made it impossible to work
If you experienced one of these issues, you can qualify for the Back to Work Program just 12 months after the occurrence, as long as you can prove the following:
- You can meet the above qualification requirements for the FHA loan
- You can prove that your credit has bounced back since the occurrence
- You do not have any late payments on your rental history in the last 12 months
- You can prove that your financial hardships were because of one of the above issues
- You went through HUD counseling after getting approved for the Back to Work Program
The Back to Work Program makes it possible to refinance from any type of loan into an FHA loan, as long as you can properly prove your reasons for the financial destruction and that there is not a repeating history of delinquent payments on your credit report.
FHA Streamline Refinance
If your current loan is an FHA loan, you are in luck when it is time to refinance. Your credit does not matter for this refinance program. According to the FHA, you do not need to verify your credit, the value of your home or your income to qualify for the streamline refinance. All that you have to prove is that you have timely housing payments made. According to the FHA, this means no late housing payments in the last 3 months and only one late payment in the 9 months prior to that time. In total, that equals one late payment in the 12 months on your housing payments. If you can prove that you paid your mortgage on time, the rest of the factors do not matter – the FHA allows lenders to use the original qualifying factors for the loan to qualify for the streamline refinance. This means your credit could have dropped, your value could be lower, and you could even be underwater on your home.
The FHA Streamline Refinance is an opportunity to lower your payment and make it more affordable. This is why the FHA does not require you to prove your credit. If your credit is significantly lower than the original score you qualified with, this is a god option for you. There are some lenders that will still pull your credit, however, so you may have to shop around with different lenders until you find one that sticks strictly with the FHA guidelines and does not add their own overlays onto it.
The FHA provides a variety of options for you to refinance your mortgage even after your credit score dropped. If you have bad credit, consider FHA loans as an option. There are thousands of FHA approved lenders around the country, each of which has their own requirements regarding the different loan types. If you get turned down with one lender, do not give up; keep trying with different lenders until you find one that will allow you to take advantage of the benefits FHA loans have to offer.
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.