How to Refinance a Mortgage With Bad Credit
Credit score and credit history bumps can discourage some homeowners from refinancing. The good news: There are a number of different options available to refinance with bad credit. Understanding how each choice works may help you decide if a bad credit refinance makes sense.
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9 tips for refinancing with bad credit
1. Speak to your current mortgage company
It never hurts to call your current mortgage company to see if they’ll lower your rate, even with rocky credit. Depending on how long you’ve had your mortgage, they may offer you a new rate or better terms to keep your business. However, you should still compare rates with three to five other lenders to make sure you’re getting the best deal.
2. Check out an FHA streamline refinance
If your current mortgage is backed by the Federal Housing Administration (an FHA loan), you may qualify for an FHA streamline refinance. You won’t need income documentation or a home appraisal, though you’ll need to prove you’ve made payments on time the past 12 months. A few drawbacks: You can’t roll costs into the loan, unless you get an appraisal or ask the lender to increase your interest rate, and you’ll have to pay FHA mortgage insurance again.
3. Try a regular FHA refinance
A key advantage of an FHA refinance versus a conventional refinance is you can borrow up to 97.75% of the appraised value of your home with a credit score as low as 580 — the conventional minimum score is 620. Credit scores don’t impact FHA mortgage insurance premiums, so this could save you hundreds of dollars monthly compared to conventional mortgage insurance premiums, which are credit-score driven.
Good News for Borrowers Paying FHA Mortgage Insurance
4. Consider an FHA cash-out refinance
An FHA cash-out refinance allows you to borrow more than you currently owe and pocket the difference in cash with a credit score as low as 500. This may be a great option to pay off maxed-out credit card balances and boost your credit score. One caveat about FHA cash-out refinancing: You can’t borrow more than 80% of your home’s value or more than the FHA loan limits in your area, which are $472,030 in most areas but can go up to $1,089,300 in high-cost areas.
Conventional Cash-out Refinance Rate Changes for 2023
5. See if you’re eligible for a VA streamline refinance
Homeowners who already have a loan backed by the U.S. Department of Veterans Affairs (VA) can use a streamline refinance program known as the VA interest rate reduction refinance loan (IRRRL). There’s no mortgage insurance, income verification or appraisal required for an IRRRL, and as long as there’s a money-saving benefit and you’ve paid your VA loan on time, the approval process is fairly simple. Still, you may have to pay a VA funding fee unless you’re exempt.
6. Replace a conventional or FHA loan with a VA loan
Military borrowers who didn’t use their VA eligibility to purchase a home can use it to refinance and pay off an existing FHA or conventional loan, even with bad credit and little to no equity. Eligible homeowners can borrow up to 100% of their home’s value and roll VA closing costs into the loan. However, as you consider this option, note that VA funding fees are more expensive than the IRRRL option, and VA appraisal fees are usually higher than FHA or conventional appraisals.
7. Get more cash out with a VA loan
Military homeowners can borrow up to 90% of their home’s value with a VA cash-out refinance — that’s 10% more than FHA or conventional cash-out refinance guidelines allow. However, while the VA doesn’t set a minimum credit score, lenders will often require at least a 620 score. Like other VA refinance loan options, no mortgage insurance is required, though you may pay a VA funding fee.
8. Learn the USDA streamlined assist guidelines
Rural homeowners who’ve paid current U.S. Department of Agriculture (USDA) loans on time over the past 12 months may qualify for a USDA streamlined assist refinance. This refi option requires no credit review, no appraisal and no income documentation. Notably, borrowers must save at least $50 per month and may qualify even if their home is no longer located in a rural designated area.
9. Ask your loan officer about non-QM guidelines
If you’ve recently filed for a bankruptcy or foreclosure, you may still qualify for a non-QM loan. Short for nonqualified mortgages, some non-QM lenders offer programs that allow you to refinance within a day of completing a bankruptcy or foreclosure, compared to the two to seven years you’d wait for a VA, conventional or FHA loan. Expect higher rates and fees, and watch out for prepayment penalties or other risky features.
What is bad credit for a refinance?
When you’re refinancing a conventional loan, a credit score below 620 would be considered bad, since it wouldn’t meet the minimum conventional credit score requirement. FHA lenders offer refinance loans with scores as low as 500, but they charge higher interest rates to offset the risk that you might not be able to make the payment.
However, even if you have a high score, your credit might be considered “bad” because of a recent foreclosure or bankruptcy. For example, conventional lenders require that you wait four years after completing a Chapter 7 bankruptcy, even if your credit scores are acceptable.
The table below gives you the minimum credit score and waiting period requirements after a bankruptcy or foreclosure:
| Bad credit refinance program | Minimum credit score requirements | Bankruptcy waiting period | Foreclosure waiting period |
|---|---|---|---|
| FHA streamline |
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| FHA rate-and-term refinance |
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| FHA cash-out refinance |
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| VA IRRRL |
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| VA rate-and-term refinance |
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| VA cash-out refinance |
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| USDA streamlined assist |
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| Non-QM loans |
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Conventional Rate Changes in 2023
How to refinance with bad credit
If you have mediocre credit, it’s especially important to shop around for bad credit mortgage refinance companies. If you have poor credit, follow this checklist while shopping for refinance lenders:
- Get a mortgage credit report first. Check for any red flags or errors impacting your scores.
- Use a home value estimator tool to gauge your home’s current market value (you can skip this step with a streamline refinance option).
- Pick the right bad credit refinance loan program using the table above.
- Provide the same financial information to all refinance lenders for accurate loan estimates.
- Be candid about any major credit issues (i.e. history of late payments, bankruptcies or foreclosures).
- Get all of your price quotes on the same day, when possible.
- Get a written rate lock confirmation once you choose a lender.
Steps No. 1 and No. 2 are crucial to get an accurate rate quote from a refinance lender that specializes in bad credit. Start with your current mortgage company and have them pull your credit score so you know where you stand.
An online home value estimator will give you a ballpark idea of your home’s current market value, which is especially important for a cash-out refinance.
Should you refinance with bad credit?
You should refinance with bad credit if you’ll break even on the closing costs before you sell your home. You can calculate your break-even point by dividing the total closing costs by the amount you’ll save monthly. For example, if you spend $7,500 to save $300 per month, you’ll recoup the costs after 25 months. As long as you intend to stay in the home at least that long, the refinance makes sense.
How to avoid a bad credit refinance
You may avoid a bad credit refinance altogether if you:
- Reduce your credit card balances. For the best scores, don’t charge more than 10% of your total available credit.
- Pay your bills on time. Any new late payments will set your credit score back.
- Avoid authorized user cards and cosigned debt. You’re responsible for the credit actions of others in cosigning arrangements, so stay away from them if you can.
- Limit any new credit applications. Your score is dinged every time you apply for a new credit account, so wait on any new credit inquiries until after your refinance is complete.