Refinancing a home loan with bad credit

Interest rate hikes have dialled up the pressure on borrowers this year. As a result, many have been keen to refinance their home loans and escape rising repayments. But if it’s been several years since you first took out your mortgage, it’s possible many important parts of your home loan application may have changed – especially your credit score. 

Having good credit when refinancing your mortgage can make a significant difference. It demonstrates to a lender that you meet your financial obligations, and that the reason you’re refinancing your mortgage isn’t to get away from a bad situation, but to find a better deal. 

So if you’ve received a bad credit report, how does it affect your chances of successfully refinancing? And can you fix your low credit score?

Let’s dive in.

Lenders look at many different things when assessing your home loan application, including your credit score. A credit score indicates how reliable you are at repaying your debts – the higher the number, the more likely it is you’ve been making timely payments. 

Because home loans are a significant source of credit, it makes sense why your credit score matters to lenders. While it’s not the most important part of your mortgage application, it can make a difference to your chances of getting approved. 

Ideally, your home loan credit score should fall within the ‘good’, ‘great’, or ‘excellent’ ranges for the different credit reporting bodies. 

If your credit score is less than ‘good’, however, it can look like a red flag to your home loan lender. 

Credit scores can seem like mysterious numbers, but there are a few ways you can unintentionally hurt your credit score. The most common? 

• Missing or ignoring bills.
• Defaulting on your debts. 
• Opening too many lines of credit.

Borrowers with the best credit scores will have a history of making payments completely and on time, and keep any new debts to a minimum. 

Keep in mind a credit default can be something as minor as not paying a bill worth more than $150 for sixty days after you were first contacted. These mistakes will stay on your credit report for up to five years, so a silly mishap can seriously hurt your ability to refinance in the near future. 

Credit reporting bodies like Ilion, Experian, and Equifax all have different scoring systems for credit, so what counts as a ‘bad credit score’ varies. Generally speaking, however, a bad credit score for a home loan application is anything below the 500 - 600 range.

For refinance applications, your credit matters more than usual. If your score has changed a lot since your initial home loan, it could indicate you’ve financially struggled with your debts,  such as credit card or energy bills, or that you’ve even mishandled your mortgage repayments. 

However, most lenders usually won’t reject your home loan application on a bad credit score alone. Your income, debts, and loan-to-value ratio are also important because they indicate your degree of financial risk. However, a bad credit score can make a mortgage lender think twice about giving you a loan, so it’s important to get it right. 

Think of a bad credit score on a mortgage application like a bad review from your ex on your dating profile: it may not be the worst, but it does make things weird. Your home loan lender just wants to feel good about swiping right on you, so avoid anything that could be a deal-breaker. 

Refinancing your home loan is a major financial decision, but it can come with many crucial benefits, such as:

• Lower interest rates.
• Lower and/or fewer fees.
• Consolidation of debts.
• Better home loan features, like an offset account.

Refinancing can even bring you onto a different kind of home loan. Sick of variable rates? It could be time to fix your home loan rate. Planning some renovations for your rental property? Maybe switch your investment loan repayments to interest-only for a time. 

Given how costly mortgage repayments can be, it’s important to minimise their impact on your budget and keep things affordable. Refinancing is usually a last resort, but when you need it most, it pays to be able to switch with ease. 

Bad credit can slow down the process, but if you’re in a bind and you need to make a decision, refinancing could still be the best move available to you. 

If you have bad credit, your home loan refinancing process comes with a few extra steps. Otherwise, however, you follow the same overall path for refinancing.

Here is how you can still refinance your home loan, even if you have bad credit:

1. Assess your credit score. You need to know how bad your credit score is before you can fix it. Figure out how you got into this situation in the first place, and take some steps to do better in future. 
2. Improve your credit score, if possible. There are some ways to clean up your credit report – we’ve expanded upon them below.
3. Evaluate your debt-to-income ratio (DTI). Your DTI shows lenders how much you earn and how much you’ve borrowed. Ideally, they don’t want mortgage repayments competing with other debts for your hard earned money, so the fewer debts, the better.
4. Shop around for the best home loan deal. Compare home loan features and interest rates so you can find the right offer for you. Now is also a good time to speak to a financial planner, especially if you have bad credit. 
5. Prepare your refinance application. You’ll need all the paperwork ready to go, so get your ducks in a row and prepare to lodge your application.
6. Apply. 

One of the biggest mistakes you could make when refinancing with bad credit is to do nothing about it. Your situation has changed since your first home loan application, so you’ll need to change with it. Take steps to improve your credit, seek expert advice, and get all your paperwork together. 

Once your lender sees you’ve taken financial responsibility, they’re more likely to look on your application favourably – even with bad credit.

The first step to improving your credit score when applying for a home loan is to know what it is. Request a free credit report from a few reporting agencies, like Experian or Equifax, and have a look through it. 

If you see any errors on your credit report, have them corrected. This can go a long way to building up your score again. 

Once your credit report is accurate, start paying down your outstanding debts. This can include everything from credit cards and Buy Now Pay Later platforms like Afterpay to HECS-HELP student loan debt. 

Next, make sure you’re paying all your bills on time. Some easy ways to do this include setting automatic payments or direct debits with your providers, although recurring calender alerts can help, too. 

Finally, consolidate how much credit you have on hand. Lower your credit card limits, avoid taking out any new debts, and limit your home loan refinance applications to one at a time. Having too many ‘hard enquiries’ on your credit report makes it look like you’re either reckless or desperate for credit, neither of which makes you look good as a borrower. 

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