Mortgage Tips: Pros and Cons of Refinance Loans for People with Bad Credit

If you're burdened with high credit card bills and your credit rating is declining, a home equity loan can be an effective way to improve your credit score quickly. Upon closing the loan, homeowners receive cash to pay off their debts, leading to an immediate enhancement in their credit rating.

Banking executive Dan Ambrose refers to these as "band-aid loans," also known as 2/28 loans in mortgage terms. These loans are typically short-term, designed for individuals with less-than-perfect credit. They feature a fixed interest rate for the first two years, after which they adjust to a variable rate that fluctuates with the prime rate.

The downside to the "band-aid loan" is that it often comes with higher interest rates for those with lower credit scores. Dan cautions consumers to be prepared for the adjustment period, as the interest rate could increase significantly, resulting in higher monthly payments than the original loan.

If consumers use the equity loan to pay off their bills completely and maintain perfect mortgage payments for 18 months, Dan suggests their credit score will improve substantially, making them more attractive to other lenders.

However, it’s crucial to be aware of the current housing market. According to Dan, real estate values are declining in many areas, which could affect the amount of equity available. If home values drop, homeowners might not have sufficient equity to cover their debts. This scenario could result in higher payments after the initial fixed-rate period, potentially worsening the homeowner’s financial situation.

For those with marginal credit or insufficient equity, a 125% loan might be an option. This type of loan allows you to borrow more than your home's current value. It’s essential to consult with a mortgage professional to assess whether the credit risk is worth the potential benefits.

Ultimately, Dan emphasizes the importance of using the equity cash to pay off debts rather than indulging in non-essential expenses like vacations. Properly managing the funds from a home equity loan can provide significant financial relief and improve your overall credit standing.