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The concept of refinancing is a simple one: you take out a new mortgage and use your new loan to pay off your old loan.

For most homebuyers, the process is familiar. It’s nearly the same steps as financing the first mortgage, except you get to skip all the parts where you’re searching endlessly for a property to buy. You’ve already got the property, and now you’re looking to get a better deal on it.

Like your first mortgage, getting a good deal, i.e. the best rates, depends a lot on your creditworthiness. Here’s what you need to understand about refinancing and the steps you need to take to help make sure your credit is ready.

Importance of credit in refinancing

A good place to start is to assess your goals. You’ll want to look over the total financial situation of your household, including current loans and savings, and figure out what goals you want to achieve with a refinance. Are you trying to get a lower interest rate? A smaller monthly payment? Shorter loan term? Figuring out what benefits you’re seeking will help you find the right kind of refinancing.

Your credit will be key to getting approval on a new loan. Lenders want to make sure they’re not taking a huge risk by issuing you another loan, so they will want to see that you have a good record of paying your debts. Before you begin this process, check your credit report. Doing this ahead of time will help you avoid any surprises during the approval process and give you time to improve your creditworthiness. Raising your credit can be done by paying down your debts, making sure you are paying bills on time, and avoiding opening too many new accounts.

Understanding the impact of credit on refinancing

Banks may look at your creditworthiness to determine how risky of an investment you are. A higher credit score is ideal and can result in lower interest rates; a poor credit score may end up costing you more money in the end because you could end up with higher refinance rates to balance out the lender’s risk. Borrowers with good credit can sometimes get fast-tracked loan approval. Good credit may also lead to favorable loan terms with lower fees or an option of rate types (fixed vs. variable rates).

Reviewing your credit report

No matter your credit status, you don’t want to be surprised by anything on your credit report. You can request copies of your credit reports through various resources online. Doing this ahead of time will give you a window to review the report before refinancing and correct any errors or discrepancies.

Implementing strategies to build your credit

Building your credit can take time but can save you a lot of money on a loan in the long term. Consider these strategies when working toward building up your credit:

Prioritizing high-interest debt

Debts with the highest interest rate run the greatest risk of running up more debt and hurting your credit. Paying these off first can be a first step toward rebuilding credit.

Utilizing debt repayment strategies

Making timely payments is key to any credit-building strategy. Late payments can lead to further damage to your credit. Late payments may be avoided by setting up automatic payments through your bank or setting calendar reminders for yourself.

To pay off debts, some borrowers use the snowball strategy – paying off small debts first and using the extra money to then pay off the next smallest, and so on; others go for the avalanche approach – prioritizing debts with the highest interest first, which may be a more cost-effective approach.

Avoid new credit inquiries or applications

Creditworthiness often benefits from stability, so it’s usually a good idea to minimize opening a lot of new credit lines or other loans. You want to avoid too many “hard inquiries” into your credit file, which occur when you apply for a new line of credit and the lender requests a copy of your credit report. Too many such inquiries can make it seem like you are applying for too many lines of credit.

Keep credit balance low

Maintaining a low balance may help keep your credit in good shape. An important part of this is keeping a low credit utilization ratio, which is your total balance across all your credit accounts divided by your total credit limit. Paying down balances as soon as you can, may help improve your credit.

Allotting sufficient time for credit improvement

Working on your credit can take some time. Problems with your payment history often make up a big part of your creditworthiness. Fixing them can take months or even years. Improving your credit utilization ratio takes time as well and can have a large impact. Another factor to consider is your length of credit history. The longer a credit account has been open, the more positively it will reflect on your credit.

Staying consistent and diligent is crucial. Significant changes to your credit won’t happen overnight, but they will show up in time with good financial management.

Monitoring your progress and adjusting strategies accordingly

With this gradual but consistent process of improving your credit, it’s important to check your progress over time. “Soft” credit inquiries don’t hurt your credit and can be requested online. Keep your eyes on changes over time and be ready to adjust strategies based on your progress and feedback from credit monitoring tools. Consider seeking advice from financial advisers or credit counseling services for extra guidance.

Considering alternative options if credit improvement is limited

Several loan programs cater to borrowers with poor credit. Federal Housing Administration loans may accept people with poor credit, subprime lenders specialize in higher-risk loans, and credit unions offer more flexible options.

Seeking a co-signer or guarantor can help strengthen a loan application as well. The co-signer’s good credit may help approval odds and secure better loan terms.

But it might be that delaying refinancing is the right move for now if your needs are not immediate. Waiting to improve your credit score can lead to lower interest rates and long-term savings. For example, getting a FICO^® score from the low 600s to above 700 may help lower interest rates by several percentage points.

Disclaimer: Article content is intended for information only. It may not reflect the publisher nor employees’ views. Consult a mortgage professional before making financial decisions. Publishers or platforms may be compensated for access to third party websites.