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Can You Refinance a Mortgage With Bad Credit? | Mortgages and Advice
If your credit score is lackluster, you may worry that it could prevent you from refinancing your mortgage. Luckily, a refinance can be difficult but not impossible. Here’s what you need to know about how to refinance your mortgage with bad credit.
Options for Refinancing Your Mortgage With Bad Credit
Mortgage lenders typically look for a credit score of at least 620 to refinance conventional loans, but standards are more flexible with government-sponsored mortgages.
Here are some options to explore for refinancing with bad credit. Eligibility usually depends on who owns your mortgage and whether you meet the requirements.
FHA Rate-and-Term Refinance
You may be able to do a rate-and-term FHA refinance with a credit score of 500 to 580, but those loans can be hard to access. That’s because you have to find an FHA-approved lender, and lenders can add their own guidelines to the FHA’s rules.
Stephanie Amedee, branch manager and licensed loan originator at Semper Home Loans Incorporated, says, “FHA allows (a credit score) down to 500. The problem with it going down to 500 is you’ll be hard-pressed to find investors that will purchase a loan that has a credit score that low, and so in my experience, I don’t see anything under 550 generally being underwritten.”
FHA Streamline Refinance
If your credit score is on the low side and you’ve had an FHA mortgage for at least 210 days, you may be able to refinance through the streamline program. Streamline refinances are available in credit-qualifying and non-credit qualifying options.
The difference between the two is that the lender can approve the non-credit qualifying loan without a credit check or home appraisal. You will need to show you’ve made six consecutive mortgage payments.
USDA Streamlined Assist Refinance
Eligible homeowners can refinance USDA home loans without a credit check, debt-to-income ratio evaluation or home inspection. You must be current on your mortgage payments during the 12 months before refinancing.
VA IRRRL (Interest Rate Reduction Refinance Loan)
If you have a VA-backed home loan, you may be able to reduce your monthly mortgage payments through this streamline program. Loans typically don’t require a credit check or appraisal, and you can refinance up to 100% of your outstanding loan balance. You’ll need to show you’ve had the loan for at least 210 days beyond the first payment due date and made six consecutive monthly payments.
Fannie Mae’s RefiNow or Freddie Mac’s Refi Possible
These programs were developed to help low-income homeowners refinance more easily. Fannie Mae or Freddie Mac will need to own your loan to qualify, and you must meet income, DTI ratio, payment history and loan-to-value ratio requirements.
Portfolio Refinance Loan
You may qualify for a portfolio refinance loan, a mortgage the lender originates and retains instead of selling on the secondary market. Lenders can set their own approval standards for these mortgages and may be more flexible with credit score requirements.
Non-Qualified Mortgage
A non-qualified mortgage, or non-QM, often uses alternate methods to gauge your ability to repay the debt instead of your credit score. It may also allow for recent credit issues like bankruptcy or foreclosure. However, a non-QM refinance loan may have potentially risky features that a qualified mortgage doesn’t permit, such as interest-only payments or repayment terms longer than 30 years.
Loan Modification
Amedee says a loan modification could be a good option if you’re facing default or foreclosure and can’t qualify for a refinance. Your existing lender may roll any past due amount into your mortgage balance, lower your interest rate or re-amortize your loan to give you a lower monthly payment. If you’re experiencing financial hardship, contact your mortgage holder as soon as possible to discuss potential relief options.
How to Refinance Your Mortgage With Bad Credit
If you’re trying to refinance a mortgage with bad credit, there are several steps you should follow:
- Check your credit score. A FICO score between 300 and 579 is considered poor, and scores between 580 and 669 are fair. Once you know your score, you can prepare your finances and apply for the right mortgage program.
- Calculate your debt-to-income ratio. Your DTI ratio is the percentage of your monthly income that goes toward debt. Typically, your DTI ratio should be less than 43% to qualify for a mortgage (the lower, the better).
- Boost your cash reserves. Showing a lender that you have cash on hand to cover the mortgage during financial emergencies may strengthen your refinance application. Experts recommend keeping an emergency fund of at least three to six months of your typical expenses.
- Ask your current lender. Since you already have a relationship with the financial institution through your first mortgage, that bank may be more willing to work with you – especially if you have a flawless payment record.
- Shop around with different lenders. Get rate quotes that rely on soft inquiries, which won’t harm your credit. Also, ask about fees and closing costs you might pay, which can help you figure out whether to move forward with the lender.
- Seek advice based on your situation. “It’s a good idea to have a lender review (your) loan application and credit to see if there’s anything that can be done to help improve (your) credit score and put (you) in line to be able to refinance,” says Amedee.
- Enlist a co-signer. Adding a borrower with good credit to your mortgage refinance application can increase your odds of qualifying for the loan or getting a better interest rate.
- Rate shop within a 45-day window. Consider applying with at least three lenders to compare costs and get the best rate, even with bad credit. Multiple mortgage applications within a period of two to six weeks will count as just one hard inquiry.
- Consider getting a rate lock. A rate lock can secure a set mortgage refinance interest rate until closing day, which could help ease your nerves as interest rates regularly increase in today’s environment. Be aware, however, that you could get stuck paying more for your loan if rates decrease during the lock period.
Rebecca Richardson, branch manager and loan originator at UMortgage, says, “Most of the time, there’s going to be some kind of floor for the credit score. So either you’re there or you’re not.” However, if you’re barely meeting that requirement, you can increase your approval chance by having a low DTI ratio or substantial cash reserves.
Benefits and Drawbacks of Refinancing With Bad Credit
Refinancing your mortgage could result in both benefits and drawbacks to your financial situation. Here are some of the potential pros and cons you should weigh as you determine how to move forward.
Potential Benefits of Refinancing
- Address personal circumstances. If you’re getting divorced, you can get your name or your soon-to-be former spouse’s name off the mortgage by refinancing the loan.
- Get rid of private mortgage insurance. If you have at least 20% equity in your home, you may be able to ditch private mortgage insurance by refinancing your loan.
- Reduce your monthly payments. Refinancing your mortgage to a longer repayment term could result in smaller required monthly payments, freeing up cash in your budget for other goals.
- Become debt-free sooner. On the other hand, refinancing your mortgage to a shorter repayment term can help you pay off your loan faster (and save money in interest).
- Lock in a fixed interest rate. If you have an adjustable-rate mortgage , refinancing to a fixed-interest-rate loan will give you stable and predictable monthly payments.
- Save money over the long term. Refinancing your home loan could help you save money if you hang onto the property long enough after closing or if interest rates have decreased since you took out your original mortgage.
Potential Drawbacks of Refinancing
- Pay more in interest. Mortgage interest rates have increased sharply in the last few years, so even folks with excellent credit may end up paying significantly more in interest depending on when they originally closed on their home.
- Cough up closing costs. You may have to pay up to 6% of the property’s value to close your refinance deal.
- Increase your monthly payments. Refinancing to a shorter term can result in dramatically larger monthly payments because you’ll have to pay off your debt over less time.
- Prolong the period of indebtedness. On the other hand, refinancing to a longer term can mean having a mortgage for years (or decades) to come and paying more in interest over the life of the loan.
- Take a credit score hit. Taking out a new mortgage can result in a small, temporary credit score reduction, partly because the lender performed a hard inquiry on your credit before issuing the loan.
- Reduce the equity in your home. If you take cash out of your home when you refinance, your equity will decrease.
As you move through the decision-making process, it’s critical to keep two things in mind: your reason for refinancing and your long-term plan for the property. For example, let’s say you want to refinance to tap into your home equity and pay off higher interest debt. Richardson says you must have the right mindset and discipline for this transaction to benefit you. If you don’t, you could rack up more credit card debt, ultimately sacrificing your home’s equity without improving your overall situation.
In addition, Richardson says, if you “plan to move in the next six months or a year (refinancing) might not make sense.” You can see how long you need to keep the property to come out ahead by calculating your break-even point.
Here’s how: Divide your closing costs by the amount you expect to save every month to figure out how long you’ll need to recoup the upfront costs of the loan. For example, if you pay $5,000 to refinance and save $100 a month, you’ll break even in 50 months.
Finding a Lender to Help You Refinance a Mortgage with Bad Credit
Many mortgage refinance lenders won’t work with you if you have a poor credit score. However, some banks may be willing to look past this financial metric, including:
You might be able to find other options by running internet searches, asking friends who’ve recently refinanced their mortgage or speaking with financial professionals.
How Can You Improve Your Credit to Refinance?
- Pay your bills on time. This is the biggest factor that can influence your credit score.
- Reduce your debt. Try to use no more than 30% of the available credit on your credit cards, and pay off student loans and car loans if possible.
- Pull your credit reports from AnnualCreditReport.com. You can now indefinitely access each report online weekly for free. Look for inaccuracies and instances of fraud, which could pull down your credit score. Dispute errors with the credit reporting agencies.
- Become an authorized user. Ask someone with a strong credit history, such as a family member or trusted friend, to add you to a credit card account.
- Avoid applying for credit, which could raise questions about your financial stability.
- Keep credit card accounts open to maintain the length of your credit history.
Amedee says, “A lot of lenders have access through the credit company that they’re working with to run simulators on what you can do to improve your credit score.” Then, once you make the necessary changes, you can wait for your credit score to naturally reflect them (which may take a month or more). Or, you can ask your lender to initiate a rapid rescore, which is when the financial institution submits documentation of the changes directly to the credit bureaus and asks for your credit score to be recalculated.
This strategy can work well if your low score is due to a high DTI ratio and you pay down your account balances to lower it. However, if your credit report has derogatory marks on it, such as collections or charge-offs, you may be better off working with a credit specialist or other financial professional, says Amedee.
