Refinancing a home loan with bad credit

How bad credit can affect your refinancing chances

If you successfully applied for a home loan in the past, this doesn’t mean you’re automatically eligible for a new one - especially if you no longer have good credit. 

Refinancing a home loan involves going through the application process again, in which the lender will assess your creditworthiness. This is where bad credit can prevent you from nabbing a competitive interest rate, or gaining loan approval full stop. 

Most lenders reserve their most competitive refinance mortgages for borrowers most likely to pay back the loan and the interest. To a lender, an “ideal” borrower is one that can demonstrate both security (based on savings and/or equity), and non-risky behaviour (based on strong credit history and ‘good’ to ‘excellent’ credit score). 

If your credit score comes up short, you may not satisfy the lending criteria for the mortgage. Even if you’ve built up equity in your existing loan, if you’ve previously defaulted on a repayment and gone into arrears, or you’ve taken on additional debts such as personal loans, you may be deemed too much of a financial risk to be offered a new home loan. 

What are your refinancing options when you have bad credit?

Whatever your purpose for refinancing is, the standard refinancing process can be more challenging if you have poor credit history right now. These are some of the options available to homeowners who are considering refinancing and want to boost their chances of approval.

Boost your credit score

Unless you’re approaching the end of a fixed period and need to refinance immediately, it may be worthwhile taking some time to boost your credit score. Sometimes, it’s a better option to wait to refinance until you’ve had a chance to clear up some of your credit issues. 

Problems, such as past defaults and bankruptcy, can take up to 7 years to clear from your credit history, but you may be able to resolve some other credit issues in the shorter term. Paying off or reducing outstanding debt can often help boost your credit score, as can keeping a clean repayment record on your current loan.

There are a range of ways that Australians can work to improve their credit score, including:

• Check for errors - Grab a copy of your credit report from one of the three major bureaus, Experian, Equifax or illion, and go through it with a fine-tooth comb for errors or inconsistencies. Sometimes someone else’s credit behaviour can end up on your report, especially if they have the same name as you or are a family member.
• Automate your repayments - Setting up automated payments can help you to avoid missing future payments, and will demonstrate positive payment behaviour as you shouldn’t miss a future bill. Keep in mind that bills, like mobile phone and energy bills, can also affect your credit score.
• Pay more than the minimum repayment - Don’t be tempted to pay only the minimum on your credit card bill, as this can turn a small debt into a gigantic one through interest charges. By paying more than the minimum repayment amount on your credit card, you’ll not only reduce your debt to income ratio, but demonstrate positive payment behaviour.
• Lower your credit limits -Reducing your credit limit could help to lessen the temptation to spend and accrue more debt that may in turn hurt your credit score. Further, lenders typically assess your refinance application and test your income as if you have maxxed out your credit limit. A lower limit, especially while you’re trying to refinance, may reflect positively on your credit score and/or refinance application. 

Keep track of your changing credit score with RateCity's helpful Credit Score App. Get a free copy of your credit scores with Experian and Equifax in a matter of minutes. 

Consider a specialised lender

If you don’t have time to spend boosting your credit score right now, you may want to consider a specialist non-bank lender. 

Some of these lenders are specialists in non-traditional loans, such as bad credit mortgages or mortgages for self-employed applicants, and may be flexible enough to provide a refinancing package that suits your financial situation. These loans are not typically offered by the big four banks and other major institutions, so you’ll need to do your research around lenders that may suit. At the time of writing, RateCity does not currently have bad credit home loans on our comparison tables.

Keep in mind that the interest rates and fees on these loans can often be higher than average, as to account for the risk of taking on a less ideal applicant. Because of this, you’ll want to avoid paying one of these loans for longer than you have to. Once you’ve done the work to reduce your credit risk to lenders, you may want to refinance from your bad credit loan back onto a more typical mortgage. 

Consider a joint application

Another option that may boost your refinance home loan application is to have another person (typically a spouse) come on as a joint applicant.

With a joint home loan, the additional person may boost the application with their own personal financial history, assuming they have a ‘good’ to ‘excellent’ credit score. Lenders may be more likely to approve a joint application as it offers double the income supporting the loan repayments, and a better chance of recovering the money if one party defaults.

Approval is not guaranteed however, as some lenders will still reject any application if one party has a poor credit score. It is worthwhile speaking to the lender first and grabbing a copy of the terms and conditions or product disclosure statement to assess this. 

Consider a guarantor

A guarantor home loan involves having another party, typically a parent or close family member, use the value of the equity in their own home as additional security. This is most commonly utilised to help cover the cost of a home deposit for first home buyers, but can also be useful for Australians with bad credit, those on Centrelink benefits, those not employed full-time or younger Australians with little to no credit history. 

For a refinancer, the guarantor may agree to support the full mortgage or may choose a limited guarantee that only covers part of the loan. Having a guarantor come on to your home loan when you refinance may be one option that boosts the chances of approval for a bad credit home loan applicant. 

That being said, a lender will still want to ensure you can afford your home loan repayments moving forward, and are not at risk of default. It may be worthwhile using a Mortgage Repayment Calculator beforehand to make sure a guarantor home loan suits your budget.