Refinancing your mortgage can make financial sense for many reasons. You can reduce your monthly payment, get a new loan term or convert your home equity into cash. But refinancing may not be so cut and dry if you have bad credit. You may have to do more legwork to find viable options. Otherwise, the costs of refinancing outweigh the benefits.
So, before moving forward, it’s worth understanding how refinancing works and the potential impact of a bad credit score. You should also be aware of your options and how the application process works so you’ll know what to expect.
How Mortgage Refinancing Works
Mortgage refinancing involves swapping out your current home loan with a new one, typically with a different term and interest rate. You can use a mortgage refinance to:
- Get a lower interest rate and reduce overall borrowing costs
- Extend the loan term to get a lower, more affordable monthly payment
- Leverage your home equity to consolidate debt, fund home repairs or renovations, make a big-ticket purchase or however else you see fit
- Switch from a variable rate (ARM) mortgage to a fixed-rate mortgage
Upon approval, proceeds from the new mortgage are used to pay off the original mortgage. You’ll also begin making payments on the new loan, which could be lower depending on the loan terms you’re eligible for.
Can You Refinance a Mortgage with Bad Credit?
It’s not impossible to refinance a mortgage with bad credit. Still, it can be challenging unless you do your homework first. More on that later.
What is Considered a Bad Credit Score for Refinancing?
FICO, the most prevalent credit scoring system, considers any score above 669 to be good credit. A lower credit doesn’t mean you won’t qualify for refinancing, but you may get less favorable terms.
What is the Minimum Credit Score for a Mortgage Refinance?
The minimum credit score for a conventional mortgage refinance is generally around 620. You may have more flexibility with government-backed loans, though, as they come with more lenient credit guidelines.
FHA streamline refinances, for example, may allow you to refinance an existing FHA loan with a credit score as low as 500 if you can meet the other eligibility guidelines.
The Impact of Bad Credit on Mortgage Refinancing
Your credit score is a pivotal factor in refinancing your mortgage. It not only affects your chances of being approved but also significantly impacts the terms and costs of the loan.
Lenders use credit scores to assess the likelihood that a borrower will repay their loan. A lower credit score can signal to lenders that there’s a higher risk involved in lending to you, which can lead to less favorable loan terms.
Higher Interest Rates
Mortgage lenders view borrowers with lower credit scores as riskier. Unfortunately, this could also mean higher interest rates that could hike up your borrowing costs by several thousands of dollars over the loan term.
Higher Closing Costs
You can also expect steeper closing costs from the lender if you refinance with bad credit. These are generally in the form of higher origination fees, and some lenders also assess risk-based surcharges.
Risk of Loan Rejection
If the lender deems you too risky of a borrower, they could reject your application for a mortgage refinance. This could be solely based on your credit score or other factors, like your debt-to-income ratio, employment history and overall financial health.
Different Mortgage Refinancing Options for Bad Credit
It’s worth improving your credit score before applying for refinancing. But if you’d like to refinance sooner than later, some options could work for you.
Conventional Refinance
Although most lenders prefer borrowers with good or excellent credit for conventional refinances, some may be willing to approve you. You’ll likely need a solid payment history and equity in your home to qualify.
FHA Refinance Programs
There are four options available if you currently have an FHA-insured home loan:
- FHA Streamline Refinance: allows you to refinance a current FHA loan to get a lower rate or different term
- FHA Simple Refinance: designed to lower your interest rate and monthly payment minus the hefty documentation and appraisal requirements
- FHA 203(k) Refinance: an ideal option to cover home renovation costs
- FHA Cash-Out Refinance: lets you pull equity from your home and adds the amount you withdraw to a new loan
VA Refinance Programs
You can also explore VA refinance programs if you’re in the armed forces, a veteran or a qualifying spouse. They include:
- VA Interest Rate Reduction Refinance Loan (IRRRL): allows veterans with current VA loans to secure a lower interest rate without providing a ton of paperwork or undergoing an appraisal
- VA Cash-Out Refinance: enables veterans to finance their current VA or non-VA mortgage and pull cash from their home equity
USDA Refinance Programs
If you have an existing USDA loan, consider these refinance options:
- USDA Streamlined Refinance: ideal if you want a streamlined refinance process but may require a credit check and appraisal
- USDA Streamlined-Assist Refinance: features a simplified process, minus a mortgage appraisal
- USA Non-Streamlined Refinance: an option that requires a credit check, mortgage appraisal and income review
- USDA Pilot Refinance: available in select states for borrowers with USDA Section 502 Guaranteed Loans, and typically doesn’t require an appraisal
Portfolio Refinance Loan
Some lenders hold and manage your loan within their investment portfolio, known as a portfolio loan. These lenders might offer refinancing options that are catered to your unique financial situation, even if you have less-than-perfect credit.
Fannie Mae’s RefiNow or Freddie Mac Refi Possible
For those with lower incomes and not-so-perfect credit, the Fannie Mae RefiNow program or Freddie Mac’s Refi Possible program offer accessible refinancing with benefits such as reduced documentation and often no minimum credit score requirements. These programs aim to make refinancing more attainable for a broader population of homeowners.
How to Apply for a Bad Credit Mortgage Refinance
When you’re ready to apply for refinancing, here’s what to do next.
Preparing Necessary Documents
Gather any documents you’ll need in advance to avoid hiccups or delays during the application process. Most lenders will request:
- Proof of income: Recent pay stubs, W-2 statements or tax returns
- Asset information: Bank statements and investment account records
- List of debt: Current monthly obligations for debts you owe
You should also get a copy of your credit report from the three credit bureaus – Experian, TransUnion and Equifax. Review each page, note any errors and file disputes promptly to have them corrected.
Choosing the Right Lender
Look for lenders with a history of working with borrowers with bad credit. Pay attention to the refinance options and applicable rates, and compare options to create a shortlist of lenders that could work for you.
Going through the Application Process
Select a lender and submit a formal application for refinancing. If you’re pre-approved, they will provide a loan estimate outlining the loan terms, including the interest rate and borrowing costs you can expect.
The next step is to provide any additional documentation requested by the lender. Once the underwriting team reviews it, the lender will issue a final decision.
Other Tips for Refinancing Mortgage with Bad Credit
Before applying for a mortgage refinance with bad credit, it’s worth taking action to help boost your approval odds.
Improving Your Credit Score
Your credit score plays a vital role in the refinancing process. As previously suggested, check your credit reports for errors and dispute them if necessary. Also, make timely payments and keep your credit utilization low on revolving debt, ideally below 30 percent of your total credit limit. And stay away from new credit accounts in the meantime.
Building a Healthy Payment History
A consistent payment history can contribute positively to your credit profile. Ensure you make all your payments on time for existing loans and credit cards. Doing show demonstrates to lenders you are responsible with credit despite any past issues. Be sure to bring any past-due accounts current as well.
Reducing Your Debt-to-Income Ratio
Your debt-to-income ratio (DTI) is a crucial factor lenders look at when considering refinancing. To lower your DTI, aim to pay down existing debts and avoid taking on new debt. Making extra payments on your highest-interest debts can also help reduce your overall debt load more quickly.
Ultimately, a bad credit score doesn’t automatically put you on the sidelines in the mortgage refinancing game. But you’ll need to do your homework to understand the best options in your situation and find the right lender. It’s equally important to be prepared in advance to help ensure a smooth refinance experience.
Start by reviewing your credit report for any errors that could drag down your score, and take steps to improve your credit where possible. Also, consider contacting your current lender, as they may offer more favorable terms to existing customers.
If you meet the requirements, exploring government-backed refinance options, such as an FHA streamline refinance, can also be a viable route. Remember, each lender assesses risk differently, so getting quotes from multiple lenders could help you find one willing to work with you and provide better loan terms.
With careful planning and a clear understanding of the refinancing process, homeowners with bad credit can find ways to adjust their mortgage and achieve financial relief or meet other financial goals.
FAQs About Refinancing a Mortgage with Bad Credit
Yes, you can refinance with a 500 credit score, but options are limited, and it may be more difficult. One of the more accessible programs is the FHA Streamline Refinance. This option is designed to lower your interest rate or monthly payments on an existing FHA mortgage without a comprehensive credit review. It also typically foregoes the need for a property appraisal or extensive underwriting, simplifying the process for those with lower credit scores.
Yes, it’s possible to refinance with an FHA loan if you have bad credit. The FHA provides several refinancing options to choose from.
Typically, the minimum credit score required to refinance a mortgage is around 620 for a conventional loan. However, government-backed loans through the FHA, VA, or USDA might have more lenient credit requirements, going as low as 580.
It’s challenging but not impossible to refinance with a 500 credit score. An FHA Streamline Refinance does not usually require a credit check, and you might be able to bypass some of the standard verifications if your mortgage is already backed by the FHA.
