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 refinance with a low credit score and benefits and drawbacks to consider before deciding if it’s right for you.
What is a bad credit score for refinancing?
Your credit score will determine how many options you have when it comes to refinancing. “If your credit score is below 700, your ability to refinance into a conventional mortgage is limited,” says Jeff Ostrowski, principal writer at Bankrate.
However, there are still some refinancing options for people with credit scores below 620. Those with scores below 580 have even fewer choices, but could still benefit from speaking with their lender and working to build their credit.
How to refinance your mortgage with bad credit
If you’re looking to refinance your mortgage with a low credit score, here are some options to consider.
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 (DTI) ratio and your loan-to-value (LTV) ratio, 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, that may 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
If you want to refinance and have an FHA loan, the FHA streamline refinance program can be a great option. Unique characteristics of FHA streamlines include:
- No income verification or credit check: You won’t need to submit paperwork verifying your income or submit to a credit check, meaning it’s a good option if your credit score isn’t the best.
- 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 be unable 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
These options are only available if you are eligible for VA loans and/or have a mortgage guaranteed by the Department of Veterans Affairs.
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 pay stubs. Lenders who offer this option will also require a home appraisal, and you must make at least six monthly mortgage payments before you qualify.
Like an FHA streamline refinance, an IRRRL must result in a “net tangible benefit” for the borrower. “VA homeowners must [also] be able to recoup the costs of the new loan within 36 months of closing,” says Chris Birk, vice president of mortgage insight for Veterans United Home Loans and 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.”
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 way to refinance with a low credit score 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.
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,” according to Tayne.
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. You’ll have to convince a co-signer that you have the financial capacity to repay the loan, and that you’ll put repaying the loan 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 yourself and your co-signer.
8. Fannie Mae’s RefiNow or Freddie Mac’s Refi Possible
Fannie Mae’s RefiNow and Freddie Mac’s Refi Possible allow you to refinance with bad credit.
The RefiNow program has no minimum credit score requirement and is open to borrowers at or below 100 percent of the area median income who have DTI ratios of as much as 65 percent. To qualify, applicants must also have no missed payments on a current mortgage loan over the past six months and no more than one missed payment in the past 12 months.
Freddie Mac’s Refi Possible also offers more flexible qualification requirements for those seeking to refinance with a low credit score. The program is designed for low- to moderate-income borrowers. To qualify, an applicant’s total annual qualifying income must not exceed 100 percent of the area median income. The program also eliminates the typical 620 minimum credit score requirement for mortgage loans.
Should you refinance with bad credit today?
If you have an option, it may be better to wait than to refinance right now. “Considering that mortgage rates remain around 7 percent, you’re unlikely to refinance into a better rate than what you have on your original mortgage,” says Ostrowski. While you wait for rates to drop, you can focus on building your credit.
However, many people refinance to turn their equity into cash, using it to reinvest in their homes or pay down high-interest debt. “If your intention is to take cash out of your home to pay down credit card debt, I’d urge caution: Make sure you’ve got your spending under control before you tap home equity,” says Ostrowski. “The last thing you want is to use the proceeds of a refi to pay off debt, only to find yourself in the same situation in a year.”
Benefits of refinancing
If refinancing makes sense for you, then you might reap some of its benefits, which include:
- Lower your mortgage payments: If you can secure a lower interest rate by refinancing, you’ll reduce your monthly mortgage payment and free up more of your budget.
- Eliminate private mortgage insurance: If you’ve built up 20 percent equity in your home, you could request that your lender eliminate private mortgage insurance from your loan.
- Save money on interest: 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.
- Pay off debt: If you qualify for a cash-out refinance, you can use the money from your equity to pay down other high-interest debt.
Drawbacks of refinancing
While refinancing your mortgage may offer benefits, there are also costs associated with the process, and you may not always get 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 (depending on which program you apply for), 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 create a 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 refinancing with bad credit, it’s important to think about how to improve your credit score so you have more options and better approval odds. Three ways to improve your credit score include:
- Check your credit report: 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 huge impact on improving your score.
Frequently asked questions about refinancing with bad credit
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