8 mortgage refinance options for people with bad credit

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As mortgage rates continue to hold at lows, you might be wondering whether it’s still possible to refinance, even if you have bad credit. For many borrowers, the answer is yes — here’s how.

What credit score do you need to refinance?

Before you assume you have bad credit, it’s important to understand what mortgage lenders are looking for in a borrower’s refinance application.

In general, a credit score of 670 or above is considered good, scores between 580 and 669 are considered fair and anything below 580 is considered poor. When it comes to the credit score needed to refinance, 620 tends to be the minimum for a conventional loan. FHA refinances are possible if your credit score is in the mid-500s.

It’s important to note, too, that there are lenders who work with borrowers with lower credit scores, so if your score doesn’t meet the requirements to refinance with one lender, be sure to compare other options.

8 mortgage refinance options for borrowers with bad credit

1. Try your own mortgage lender first

Mortgage lenders focus on forming relationships with borrowers. If you’re trying to refinance but have bad credit, you can try leveraging that relationship, too. It’s handy to have a source of cash when you need financing for a home, vehicle or business, so getting to know your lender is a good idea.

“First, get a referral to a specific person at a bank,” advises Leslie Tayne, a financial debt resolution attorney and author of “Life & Debt.” “Having the name of someone and something in common like the referral source is an excellent way to start building the relationship. Explain your needs and find out the options the bank can offer to you.”

What you really want is the benefit of the doubt. If a lender looks at your debt-to-income ratio (DTI) and your loan-to-value ratio (LTV), as well as other factors, and your application is in a gray zone, it can go either way. You want a “yes” — and if you have a relationship with the lender, then maybe you’ll also have an edge.

“Communicate often and be prepared with the [financials] the bank will be requesting to back up your request for funding,” says Tayne. “Being organized and responsive is vital. The banker will appreciate you helping him/her do their job better, which is to put the loan together for underwriting.”

2. Check out an FHA streamline refinance

If you want to refinance with bad credit and you have an FHA loan, the FHA streamline refinance program can be a great option. The average credit score for a borrower who refinanced an FHA loan between October and December of 2020 was 666, according to the U.S. Department of Housing and Urban Development.

With the FHA streamline refinance program:

  • You can get today’s low refinance rates.
  • You don’t need a lot of new paperwork, since the lender doesn’t need to verify income, run a credit check or do a high-cost appraisal. (What the lender must have is evidence that your most recent six consecutive mortgage payments were paid on time and in full.)
  • If you refinance within three years of when your current FHA loan closed, you might be able to get some of your upfront mortgage insurance premium refunded. This can help offset the cost of refinancing.
  • The refinance must produce a “net tangible benefit,” such as a 5 percent reduction in your monthly mortgage payment or a change from adjustable-rate financing to a fixed-rate loan.

An FHA streamline refinance isn’t a cash-out refinancing program, however. The main benefit of this loan option is to permanently lower your monthly payments.

3. Explore an FHA rate-and-term refinance

While an FHA streamline refinance is reserved for current FHA borrowers, any borrower with a high interest rate could benefit from an FHA rate-and-term refinance. Unlike the streamline program, a new appraisal and credit check are required for this type of refinance. To qualify, you’ll need to have made at least six consecutive monthly mortgage payments on time and in full.

Like the streamline program, an FHA rate-and-term refinance is not a cash-out program — the purpose is to help you reduce your monthly housing costs. All proceeds must be used to pay your existing mortgage and costs associated with the transaction.

However, an FHA rate-and-term refinance also has some important, if surprising, uses. For instance, it can be used to pay off land contracts, a form of installment financing, or if you’re getting divorced, to refinance a current mortgage and originate a new loan without the co-borrower.

4. Apply for a VA streamline refinance if eligible

If you’re VA-qualified, you can refinance even with bad credit with a no-hassle Interest Rate Reduction Refinance Loan (IRRRL), also known as a VA streamline refinance. IRRRLs are available for existing VA loans, and typically do not require a credit score or appraisal. If you’re eligible, you can do an IRRRL through any mortgage lender who offers the option.

“The VA has updated IRRRL guidelines in recent years, with a focus on ensuring the refinance makes financial sense for qualifying veterans,” says Chris Birk, director of education at Veterans United Home Loans. “Homeowners will need a minimum amount of ‘seasoning’ on their current loan in order to be eligible for an IRRRL. That typically means you must have made at least six monthly mortgage payments, although some lenders have even more stringent seasoning guidelines.”

Like an FHA streamline refinance, an IRRRL must result in a “net tangible benefit” for the borrower.

“VA homeowners must be able to recoup the costs of the new loan within 36 months of closing,” says Birk, author of “The Book on VA Loans: An Essential Guide to Maximizing Your Home Loan Benefits.” “Those costs do not include the VA funding fee or escrows.”

Birk also explains that the “minimum basis point reductions vary depending on whether you’re refinancing into a fixed- or an adjustable-rate loan. For example, a VA homeowner refinancing a fixed-rate loan into a new fixed-rate loan would need to see their note rate reduced by at least 50 basis points.”

5. Use the USDA Streamlined Assist program

If you’re eligible, the USDA’s Streamlined Assist program can be the ideal option for a refinance with bad credit because there’s no credit review required. Instead, anyone with a loan through the USDA or backed by the USDA who has made the last 12 months’ worth of mortgage payments on time can qualify.

In addition to no credit check, this program also doesn’t require a home inspection and doesn’t consider your debt-to-income ratio when determining your eligibility. Like other streamline programs, there must be a certain minimum outcome, however: at least a $50 net reduction to the monthly mortgage payment.

6. Consider a portfolio refinance loan

Another refinance option if you have bad credit: a portfolio loan. You can obtain a portfolio loan — so called because it’s held by the lender — through banks and mortgage brokers, who set their own standards for the loan, which can be more flexible than typical refinance requirements.

That doesn’t mean lenders will finance any borrower regardless of qualifications, however. They still want portfolio loans to perform, and that means they will take a careful look at your finances and credit history. If there’s been a nagging application issue that will not pass muster with most lenders, a portfolio lender could be more open.

“Lenders’ customer bases can vary depending on their customer’s target market,” says Tayne. “Some cater to smaller borrowers because it’s their specialty or primary customer base, and they’re looking to build their portfolios of small lending. Smaller borrowers typically have the potential for growth, and the more money a business is making, the more money the lender is making.”

To find out if a portfolio loan is available to you, work with a mortgage broker or a full-service mortgage lender who can shop your application to portfolio lenders.

7. Find a co-signer

If bad credit is preventing you from refinancing and locking in a lower rate, there is one strategy that can quickly change your situation: getting a co-signer.

A co-signer with strong credit and deeper pockets gives the lender more security. If the loan were to go unpaid, the co-signer is then responsible, and the lender can look to them for any shortfall.

Even among family or friends, co-signing a mortgage is a business deal. Strong co-signers worked to get their money and credit, so you’ll have to convince them that you have the financial capacity to repay the loan, and that you’ll put repayment of the loan first before other obligations.

Some difficult questions will also have to be answered. Is the co-signer also a co-owner of the property? What happens in the event of divorce, death or a simple falling-out? Both parties should have wills, living wills and any other paperwork needed to protect estates. Get help from an attorney to get the entire arrangement in writing, to protect both yourself and your co-signer.

8. Work to improve your finances and credit

As you consider your options to refinance with bad credit, it’s important to think about how to improve your credit moving forward. If none of the above refinance options work for you, it might be a good idea to take a step back, evaluate your overall financial situation and make some changes to strengthen your financial well-being:

  • Start a budget: Track the money you take in and the money that goes out. When you start a budget and stick to it, you might not only find ways to reduce expenses, but also begin recognizing the little costs that are adding up.
  • Check your credit report: All three major credit reporting bureaus — Experian, Equifax and TransUnion — are allowing everyone to check their credit reports for free every week through April 2022. You can get these free reports at AnnualCreditReport.com. When you pull your report, look for factual errors, unauthorized charges and fraud — issues like these could be lowering your score.
  • Pay down bills: While you’re making a budget, create a list of all of your debts and arrange them by size. Then, target the smallest debt and work to pay it off. By doing this, you’ll have one less bill to pay, and you don’t have to worry about late fees, since it’s paid off. The money saved each month can then be used to pay down the next bill you tackle.
  • Save money: Help yourself, no matter how small. If you put aside $8 a week — maybe from the change you get each day —you’ll have $416 at the end of a year. Once you get into the habit of saving, you’ll likely find it gets easier with each dollar you stash away. Building up a bigger savings account can make a meaningful difference in refinancing, too, because lenders look at your cash flow and reserves. With more in savings, you’ll be a stronger candidate for a refinance.

Should you refinance with bad credit?

If you have bad credit, you might be wondering if you should hold off on refinancing. If you can refinance now, it’s worth consideration. Why? It might just be a critical step in helping turn that bad credit to good:

  • You can shrink your payments. If refinancing can lower your monthly mortgage payment, you’ll free up more of your budget to pay off other debts or add more to your savings.
  • You could eliminate mortgage insuranceIf refinancing involves a new appraisal of your home, you could learn that your home’s value has increased. If the value has risen to the point where you now have 20 percent equity, you might be able to stop paying mortgage insurance expenses.
  • You could save money in the long run. If your current mortgage has an interest rate of 5 percent and you can refinance to a rate under 4 percent, you can save a lot of money over the course of the entire loan. You can use Bankrate’s mortgage refinance calculator to estimate your savings.

While refinancing can save you money, remember that it costs some, too. Be sure to account for how much it costs to refinance, even with bad credit, to make sure it’s a worthwhile move.

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Written by
Peter G. Miller
Contributing writer
Peter G. Miller is a contributing writer at Bankrate. Peter writes about mortgage rates and homebuying.
Edited by
Mortgage editor
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