Poor credit? An FHA refinance might be a solution

By Michele Lerner
Mortgage Credit Problems Columnist

While credit standards among lenders have tightened since the housing bubble burst and home values declined, some borrowers with bad credit may be able to qualify for an FHA refinance. The FHA itself doesn't make loans and doesn't set a minimum credit score, so lenders determine their own minimum credit score guidelines. While most mortgage lenders require a credit score of 620 or 640 or higher for an FHA loan, some will approve an FHA refinance with a lower credit score depending on the borrower's other qualifications.

FHA refinance requirements

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Plenty of homeowners have experienced a decline in their home value and others have experienced financial stress from underemployment or unemployment that has lowered their credit score. While not every homeowner can overcome these obstacles, an FHA refinance into a lower interest rate could reduce your monthly payments and help you reduce other debt or simply to afford your payments more easily.

Here's what you need to qualify in addition to a credit score of at least 620, depending on the lender:

  • Home equity. If you currently have an FHA loan, you may qualify for a streamline refinance for more than the value of your home. If you have a conventional loan, you'll need at least 3.5 percent equity for a home refinance into an FHA loan.

  • Debt-to-income ratio. FHA mortgage guidelines require a maximum debt-to-income ratio of 41 to 45 percent depending on the lender. You may need to pay off some debt if you can before you can qualify for a new mortgage.

  • Income. A lender will require you to document your income qualifications if you are refinancing. If you are currently working at a second job to bring in more income, that extra money can only be counted if you can prove this is an ongoing source of income rather than a temporary job. FHA rules also allow you to include the income of a family member who co-signs your application even if that person won't be living in the home. The co-signer must meet FHA credit standards.

You'll need to pay both upfront mortgage insurance and annual mortgage insurance on an FHA refinance until your loan-to-value reaches 78 percent.

Enter your current mortgage information on this page to see if an FHA refinance or a conventional loan refinance is an option for you. You may need to reduce your debt or boost your income before you can qualify, but meeting with a lender can give you valuable information about what steps you need to take for a loan approval.

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