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Some borrowers might choose to refinance to switch from an adjustable-rate to a fixed-rate mortgage or to tap into their home equity. But the decision to refinance is made more complex if you have less than stellar credit. However, there are ways to still refinance with a low credit score, and benefits and drawbacks to consider before deciding if it’s right for you.
7 ways to refinance your mortgage 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’ll need to spend some time finding the right refinance option for you. Start with your current lender or loan servicer since you are already their customer.
Contact the officer or employee you originally worked with at your lender, if they are still there. If not, “get a referral to a specific person,” says Leslie Tayne, a financial debt resolution attorney with Tayne Law Group 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.”
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, perhaps even having checking or savings accounts with them, then maybe that will be in your favor.
“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
- No income verification or credit check: You won’t need to submit paperwork verifying your income or submit to a credit check.
- Evidence of on-time payment: Your lender will require a minimum of six consecutive mortgage payments that you paid on time and in full.
- Net tangible benefits: To qualify, the refinance must produce a “net tangible benefit,” such as a 5 percent reduction in your monthly mortgage payment or a change from an adjustable-rate mortgage to a fixed-rate mortgage.
- Limited cash out: You may not be able to take out cash in excess of $500 on mortgages refinanced under this program. The main benefit of this 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 can apply for an FHA rate-and-term refinance. 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. You must use all proceeds to pay your existing mortgage and costs associated with the transaction. However, this method allows you to include second and third mortgages in the refinanced amount.
4. Apply for a VA streamline refinance or a VA cash-out refinance
If you have a mortgage guaranteed by the Department of Veterans Affairs (VA), you can refinance even with bad credit with an Interest Rate Reduction Refinance Loan (IRRRL), also known as a VA streamline refinance. IRRRLs typically require that you provide financial information such as two years of W-2s and federal income tax returns, as well as recent paystubs. Lenders who offer this option will also require a home appraisal.
“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 and author of “The Book on VA Loans: An Essential Guide to Maximizing Your Home Loan Benefits.” “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. “Those costs do not include the VA funding fee or escrows.”
If you’re a veteran with a current mortgage that is not a VA loan, a VA-guaranteed cash out refinance loan lets you replace your current loan with a new one while allowing you to take cash out of your home equity. Even if you don’t want to take cash out, eligible veterans with a current mortgage from a lender other than the VA should investigate this option.
5. Use the USDA Streamlined Assist program
Like streamlines from the FHA and VA, the USDA Streamlined Assist program doesn’t require a credit check. Instead, anyone with a USDA loan 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 new home appraisal or 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 – at least a $50 net reduction in your monthly mortgage payment.
6. Consider a portfolio refinance loan
Another refinance option if you have bad credit is a portfolio loan. These are loans that the original lender originates and retains instead of selling them on the secondary market. You can obtain a portfolio loan through banks and mortgage brokers, who set their own standards for the loan, which can be more flexible than typical refinance requirements. You’re more likely to get a portfolio loan if you’ve been a long-time bank or mortgage customer or the lender wants your business.
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 you’ve had an application issue that has not passed muster with most lenders, a portfolio lender could be more open.
According to Tayne, some portfolio lenders “cater to smaller borrowers because it’s their specialty or primary customer base, and they’re looking to build their portfolios of small lending.”
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, you can get a co-signer/co-borrower.
A co-signer with strong credit and deeper pockets gives the lender more security, but even among family or friends, co-signing a mortgage is a business deal. 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.
Delinquencies (late payments) go against both borrowers’ credit reports. If the loan were to go unpaid, the co-signer is then responsible.
You’ll also have to answer some difficult questions. 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. Seek help from an attorney to get the entire arrangement in writing, to protect both yourself and your co-signer.
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 into good.
Benefits of refinancing
If refinancing makes sense for you, then you might reap some of its benefits, which include:
- 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.
- Eliminate mortgage insurance: If refinancing involves a new home appraisal, 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.
- Save money in the long run: Refinancing to a lower rate or shorter term could save you money on interest over the loan term. You can use Bankrate’s mortgage refinance calculator to estimate your savings.
Drawbacks of refinancing
While refinancing your mortgage may offer benefits, there are also costs associated with the process, and you may not always obtain a better interest rate. Some of the drawbacks to consider include:
- Closing costs: Similar to obtaining your initial mortgage, you must pay closing costs when you refinance. Depending on where you live, closing costs can be quite steep, amounting to thousands of dollars out of your pocket.
- Longer loan term: When you refinance, you’re effectively restarting your loan repayment term and delaying your final payoff date. So you’ll be in debt longer.
- Credit score impact: Mortgage lenders conduct a hard inquiry on your profile as part of reviewing your application, which causes your score to decline temporarily. This type of inquiry can decrease your score by about five points. In addition, when you refinance, you’re closing your old mortgage to establish the new mortgage loan. This, in turn, impacts your credit history, and credit history accounts for about 15 percent of your overall score.
How to improve your credit for a refinance
As you consider your options to refinance with bad credit, it’s important to think about how to improve your credit score. Growing your credit score can give you more options. Three ways to improve your credit score include:
- Check your credit report: Through the end of 2023, all three major credit reporting bureaus — Experian, Equifax and TransUnion — will provide you with one free credit report per week. You can get these free reports at AnnualCreditReport.com. While the reports won’t give your credit score, they’ll detail all your debts and your payment history, which impacts your score. When you pull your reports, look for factual errors, out-of-date info, unauthorized charges and fraud — issues like these could lower your score.
- Reduce your credit utilization ratio: Your credit utilization ratio is a measurement of the total amount of available credit that you’re using. Reducing it by paying down the balance on your revolving lines of credit can have a significant impact on your score, as it accounts for 30 percent.
- Pay all bills on time: The most significant factor contributing to your credit score is your payment history. It amounts to about 35 percent of your overall score. Consistently paying bills on time without fail can have a significant impact on improving your score.
Next steps on refinancing with bad credit
The first step to take if you want to refinance and you have bad credit is to improve your credit score. That means making on-time payments, paying down debt and building your credit history over time.
If you have an FHA, VA or USDA loan, consider whether a streamline refinance is an option for you. If you want to do a cash-out refinance, know that you’ll need a credit score of at least 580 for an FHA cash-out refinance, or 620 for most other cash-out refinances. Otherwise, explore your options and see if refinancing right now is the best financial choice for you.
Frequently asked questions about refinancing with bad credit
You can refinance your mortgage with bad credit, but your options are limited. Options like FHA, VA and USDA streamline refinances don’t involve a credit check, but they come with other requirements and limitations. However, when you look at the credit scores needed to refinance, a borrower with a score of 640 or higher has the most options.
A score below 620 is generally a bad score for refinancing. This is the minimum score required for most refinancing options. While you can still refinance with a lower score (with an FHA refinance, for instance, you need a minimum of 580), you will have fewer choices. Also, lenders will likely quote you a higher interest rate than if you had a better score.