Debt Consolidation With Low Credit Score? FHA Refinance May Help

June 22nd, 2010

You may be like many Americans who have seen bonuses, overtime and hours cut in the past year or two. The decline in income may have forced you to decide between keeping your mortgage current or your credit cards.

Even if not, you may find yourself with more revolving debt than you can manage; even if you are no longer adding to the balances, the sums and interest charges may just seem too much to eliminate. You may even have looked into a consolidation loan–only to be told your credit score at 640 is too low.

There may yet be hope to get you out of the credit payment spiral. Although you typically pay slightly more for an FHA cash-out refinance, here are some guidelines to show you how it might help you when other loan programs can’t. Be sure to use a mortgage calculator to determine whether such a refinance is worth it.

Credit Score

FHA guidelines allow for cash-out refinances for borrowers with credit scores as low as 640; they cost approximately 0.125% more for most borrowers than if they had a credit score over 680. FHA will generally approve cash-out refinances with lower credit scores regardless of loan amount, even if your mortgage balance will exceed the conforming limit of $417,000 and you are in the “hi-balance” mortgage amount.

In addition, FHA mortgage rates for debt consolidation refinances will generally give you a lower monthly payment than a conventional mortgage rate–even with a low credit score.

Be aware that Fannie Mae or Freddie Mac cash-out refinance guidelines permit conventional mortgage applications with credit scores to 640; however, at lower credit scores, they typically charge a rate at least 1% higher than a similar FHA loan.

Loan-To-Value

A major advantage of an FHA cash-out refinance for debt consolidation is the higher loan-to-value (LTV) limit, that allows you to pay off more of your other credit obligations for no additional cost. For example, FHA will fund cash-out refinances up to 85% of the value of your home, while conventional cash-out refinances are typically available only up to 60% (Fannie Mae) to 80% (Freddie Mac) LTV (for mortgages up to $417,000 and 75% LTV; mortgages above $417,000 are limited to the maximum loan amount for your area).

Thus, if your home is valued at $250,000, FHA may fund a cash-out mortgage up to $212,500, while Fannie Mae will only allow a cash-out refinance up to $200,000. If your home is valued at $600,000, FHA may fund a mortgage up to $510,000, while Freddie Mac will fund a cash-out mortgage only up to $450,000.

Not only will FHA allow a higher loan amount, but if you have a low credit score, the rate for the higher loan amount is as much as 1.25% lower than for a comparable Freddie Mac loan. Using a monthly payment calculator, you can see that a higher loan amount at a lower interest rate can have an almost equal mortgage payment as a smaller mortgage with a higher rate of interest–meaning you get more debt pay-down for your dollars spent.

Do The Math

Using a refinance calculator, you can easily compare your current mortgage payment to a new mortgage payment after refinancing. To accurately gauge your savings from an FHA debt consolidation refinance, add all your total monthly payments for credit cards and other loans and monthly obligations to your current mortgage payment. Compare this to your estimated total payment on a consolidated loan.

If you were to pay off all of these debts and include them in your refinanced mortgage, would you save money every month? If so, then you may want to give serious consideration to using the available equity in your home to consolidate your debt payments–and provide yourself some financial relief in these difficult economic times.

Then, after consolidating your debt into a new FHA mortgage, seriously consider putting your monthly savings into an emergency savings account to provide your family a safety net until your financial condition stabilizes.

Important Information for FHA Mortgage Calculations

When using a free online mortgage calculator for FHA mortgages, you must take into consideration the mortgage insurance on FHA loans. Multiply your loan amount by 1.0225 to add the upfront mortgage insurance premium (MIP) due at closing to the loan balance; use this number as the loan amount in your mortgage calculations.

Example: If your current mortgage balance plus debt you wish to pay off totals $275,000, multiply this number by 1.0225: $275,000 x 1.0225 = $281,187. Enter this number in the mortgage calculator.

Posted By :
Dennis C. Smith is co-owner and broker of record for Stratis Financial in southern California. He has over twenty years' experience in the mortgage industry.

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