In the world of personal finance, there are easy questions and not so easy questions. Today’s reader question from Debra falls into the latter category:
I would like to know if and where it is possible to refinance your mortgage from 5.25% down to the current low with bad credit and $70,000 equity. Don’t qualify for a loan modification plan, which would take a year of grueling paperwork anyway.
Debra’s question has several components that we need to address. As an initial matter, the current interest rate on a 30-year fixed mortgage with good credit is about 3.5%. (Because rates change daily and you may be reading this article when rates are higher or lower, click here to see today’s mortgage rates.) As a result, Debra stands to save a lot of money if she can qualify for the low rate. On a $250,000 mortgage, the lower rate would save her about $260 a month.
But what about her bad credit? While we don’t have any details on her credit score, we can assume from her question that she probably won’t qualify for the lowest interest rate. While the actual score needed to qualify for the best rate can vary from time to time, as a general rule you want a FICO score of at least 760. As your score moves below 760, your rate starts to inch up. And below 620 you’ll have a hard time qualifying at any rate.
Without knowing the details of her credit file, it’s difficult to asses her options. But speaking generally, my first step would be to improve my credit. Unless you have a very recent bankruptcy or foreclosure on your credit file (she probably doesn’t have a foreclosure given that she wants to refinance), you can generally improve your credit in a relatively short amount of time. While you might not jump from say 620 to 800 in a few months, even improving your score by 20 points can have a meaningful impact on the interest rate of your loan.
I’ve written an article on exactly how your credit score affects mortgage rates, which can help you assess the affects of raising your FICO score. It doesn’t seem to me that rates will be rising significantly in the near term (although there are no guarantees), so I’d spend some time improving my score before applying to refinance. While you may not qualify for the best rate, your higher credit score may still net you a better rate than you can currently get.
As you can tell from this analysis, poor credit will affect your mortgage rate. There’s simply no way to avoid this. If your FICO score is say 650, you will not qualify for the best rate, period. The only way to get a lower rate is to improve your credit. If you don’t know your score, I’d encourage you to get it from one of several free credit scoring websites. I’d also recommend that you get your free credit report from each of the three major credit bureaus. One of the easiest and quickest ways to improve your credit is to fix any errors in your credit report. And while it may seem that errors are the exception, not the norm, they occur far more frequently than you may think. So check your credit reports regularly.
Debra’s question also raises the issue of equity. She tells us that she has $70,000 in equity in her home. The good news is that her home is worth more than she owes. But that’s not quite enough information. To qualify for the best rates and avoid private mortgage insurance, you need to have equity equal to 20% of your home’s value. With $70,000 in equity, Debra will meet this threshold if her home is worth no more than $350,000 ($70,000 / .20).
In the final analysis, Debra’s question underscores just how important our credit score is. Like it or not, that three digit number has a big impact on our finances. Bad credit is not at all uncommon. Most of us go through rough financial times. But with diligence and hard work, most people most of the time can improve their credit, thereby reducing interest on everything from mortgages to car loans to credit cards.
Published or updated July 17, 2012.