Refinancing can be one of the most effective ways to fund a home improvement project. Would-be borrowers with bad credit might be under the impression that home improvement lending is not available for them. Often, this is not the case. By taking steps to improve their credit ratings, homeowners can vastly improve their chances for qualifying for a home improvement loan.

 Bad credit can definitely impair the ability to obtain a home improvement loan, but doesn't necessarily mean refinancing that is out of the question. Borrowers can help themselves by improving their credit--a proactive approach can pay off in more available credit and lower rates.

 How Does Bad Credit Affect Loan Availability and Costs?

While there are strict laws regulating maximum rates and fees even for borrowers with poor credit histories, having bad credit generally means paying more for home improvement financing. A bad credit history may be penalized in the following ways:

• Higher interest rates: Bad credit presents additional risk to lenders and must be compensated for or they have no reason to make the loan. Interest rates can be much higher than those available to an A-rated borrower, depending on the borrower's profile and the maximum rates imposed by regulatory agencies.
• Loan to Value: Borrowers with excellent credit might qualify for a loan of up to 100% of the value of their homes. However, borrowers with bad credit may have the availability credit (amount of home equity they can cash out) severely reduced.
•  Higher fees and Less Favorable Terms: Generally borrowers with bad credit are more likely to be charged higher fees in addition to higher rates. Additionally, prepayment penalties and other restrictions may be imposed on the loan.

 Protecting Credit

Fortunately, bad credit isn’t a life sentence, and steps to improve a credit rating can pay off relatively quickly. Temporarily postponing a home improvement loan, working to better manage debt, and raising credit scores are some of the smartest moves homeowners can make. Taking the following steps can ultimately help homeowners obtain more appealing terms on home improvement financing and achieve better financial health:

Improving Credit Scores

•  A review of the credit report is the first step, and careful verification of its information is vital. Borrowers need to dispute inaccurate information and submit letters explaining events that may have brought credit down, and pointing out mitigating circumstances if applicable.
• Form and execute a plan to pay bills on time--especially the mortgage. One of the top considerations for creditors is bill-paying history--it illustrates the borrowers' willingness to pay, not just the ability to pay. Mortgage payment history is especially important to mortgage lenders.
• Reduce unsecured (credit card) debt. It generally isn't necessary to pay them off--in fact that can lower the available credit to used credit ratio and lower the overall rating. A reasonable goal is paying credit cards down to 35-40% of the total available limit.
• Resolve outstanding collections accounts. Accounts that have been sent to collections might be settled for less than the full amount. For example, a $700 bill can sometimes be settled for as little as $200, depending on the situation. Contact collections agents and make sure any settlement is acknowledged in writing and the account is cleared.

 Home Improvement Loans When Deferment Is Not Optional

Poor or bad credit doesn't necessarily prevent homeowners from getting the loan needed to finance home improvement projects. There are a number of lenders who specialize in working with bad credit borrowers. However, doing whatever is possible to improve the credit situation before applying for a loan can save money. By raising the credit score after taking a bad credit home improvement loan, borrowers may be able to improve their home and refinance to a better loan in the future.

Sources:

FTC