With unemployment reaching 10 percent and showing no signs of abating, it’s not surprising that many people are struggling to make payments on car loan, home loan, credit card and other debts.
For struggling debtors, refinancing can offer a ray of hope, as it can be used to lower overall interest rates on your debts and/or reduce minimum monthly payments. Record numbers of Americans are taking advantage of government offers and a new initiative by banks to refinance their homes. Refinancing of auto loans and other debts are also being pursued by many debtors.
If you’ve got good credit and some equity, refinancing usually isn’t that hard. For folks with bad credit, getting a loan refinanced is more difficult, but not impossible.
Refinancing basics
The primary goal of refinancing a loan is to cut interest rates, extend the repayment period, reducing monthly payments or cut risk. By changing the interest rate on a loan, you reduce the total amount you pay for the loan. Extending the repayment period will lower your monthly payments, giving you more flexibility in your personal budget. Reducing risk is a refinancing goal of many borrowers who got their loan at an adjustable interest rate.
Adjustable interest rates go up and down depending on certain indices, and when the indices are favorable they result in lower rates. In tougher times, the interest rates can increase considerably, prompting borrowers to refinance the loan to get a steady, fixed rate.
When refinancing a loan, you may be asked to pay a portion of the loan, usually 1 to 3 percent upfront. Other refinancing agreements charge no closing costs, or stack the costs toward the end of the life of the loan.
Credit basics
Credit is essentially an estimation of your ability to repay debt. Credit is determined by looking at your income, existing obligations and history of paying off other debts. Bad credit occurs when you periodically fail to pay existing debts or when your total amount of debt compared to your income exceeds a certain ratio.
Ironically, people who have no debt can also have bad credit, if their lending history is so scant as not to provide a good record of their borrowing and lending habits. The best way to build good credit, or to rebuild credit that has a few dings, is to take out and repay manageable debts. By making on-time payments on your credit card, auto loan or student loan, you can improve your credit over time.
When lenders check your credit, they largely look at your credit score. This is a numerical representation of your credit history that makes it easy for lenders to classify the amount of risk you pose to them. There are several credit bureaus who compute credit scores. The most commonly used one is the Fair Isaac Corporation, or FICO.
Refinancing with bad credit
If your FICO score is less than 620, getting a loan refinanced may be difficult for you. There are some things you can do however to get your home, student loan or other debt refinanced however.
One way, is to fix your credit problem. If you’re just under the threshold, try to get current with your debts and make consistent payments for about six months. In that time, if you make on-time payments, your credit score should inch up enough to qualify you for refinancing.
If you’re seeking to refinance an auto or home loan and you have bad credit, you’re likely to have an easier time than if you’re seeking to refinance a student loan or other debt. That’s because home and auto loans are secured loans, meaning the bank has something to take away — your house or car — if you don’t pay up.
If you’re seeking to refinance a loan and you have bad credit, you should shop around. The banking industry is currently very competitive and some banks may offer terms that far exceed or fall far below what another bank can offer. You may also want to contact a mortgage broker, if you’re seeking to refinance a home loan.
There are also a variety of government programs available to help homeowners refinance their homes, and services are extended to people with bad credit. The Federal Housing Authority runs programs that may be able to help.
Chances are that if you’re seeking to refinance with bad credit, the interest rate you receive from a lender is likely to be higher than that for a debtor with good credit. (The average is 2 to 6 points higher than refinancing with good credit.) You may also have to pay larger upfront fees. However, if you can lower your monthly payments enough to make your monthly budget more affordable, use the extra money to pay off other debts, and consistently make payments, in about two years you may be able to refinance your loan again and get better terms.