4 Options For Refinancing A Mortgage With Bad Credit
Kevin Graham7-minute read
December 11, 2020
Do you have a bad credit score? If so, you might think that a refinance is completely out of your reach. Hold up – it might not be. There are a few methods and special circumstances to help you possibly refinance with a lower score.
We’ll take a look at a few ways you can refinance your mortgage even with a bad credit score. We’ll give you a quick refresher on what a refinance is and offer a few simple tips you can use to raise your score before you refinance.
Understanding The Refinance: How It Works
A refinance is a loan that replaces your current mortgage with new terms, a new interest rate or a different loan balance. Refinancing means that you first pay off your old loan with your new loan, then make payments on your new loan.
There are a number of reasons why you might want to refinance your mortgage loan. You can:
- Change your loan terms. Are you having trouble making your monthly mortgage payments? You can refinance your loan to a longer term, which gives you more time to pay back what you owe while lowering your monthly payments. You can also refinance to a shorter term if you want to pay off your loan faster. You may also be able to refinance to a lower interest rate to save money over the life of your loan.
- Remove mortgage insurance. Do you have an FHA loan? If so, you may already be aware that you must pay a Mortgage Insurance Premium (MIP) for as long as you have your FHA loan, if you put less than 10% down on the home. Many homeowners hold their FHA loans only until they reach 20% equity, then refinance to a conventional loan. This allows them to forgo the mortgage insurance requirement and save money.
- Take cash out of your property. A cash-out refinance allows you to accept a loan with a higher principal balance than you owe and take the rest out in cash. The cash you get from a cash-out refinance can help you pay off debt, cover home repair costs and more.
Applying for a refinance is similar to applying for your original home loan. You’ll choose a lender you want to work with, make sure you fit their qualifications and apply.
The lender will ask you for some financial documentation, order an appraisal and underwrite your loan. You’ll then get a Closing Disclosure that includes your new loan terms and the costs you need to cover. Finally, attend a closing meeting with a settlement agent, sign on your new loan and start making payments.
Your Options For Refinancing A Mortgage With Bad Credit
Your credit score plays a major role in your ability to get a refinance. Certain lenders may not be able to give you a loan if your score is too low. However, there are a few options for refinancing with a credit score that’s less than ideal.
1. Apply With A Non-Occupying Co-Client
One option is to apply for a refinance with a non-occupying co-client. This is someone who doesn’t live in your home but is willing to take financial responsibility for your loan if you default.
In this situation, your lender considers both of your credit scores, income and assets when they underwrite your loan. Depending on the type of loan you get, your co-client may need to also be on the title of your home.
The credit score that counts is the lowest median credit score between the two of you, so although having a co-client can help you with lowering your debt-to-income ratio (DTI), you’ll still need to qualify from a minimum credit score perspective.
Applying for a refinance with a co-client can give you a boost but remember that there are some strings attached. Your refinance provider can pursue your co-client for the money if you fail to pay back your loan. Make sure you can handle your payments every month before you apply for a refinance — and make sure to maintain a great relationship with your co-client.
2. FHA Streamline Refi
This option allows you to refinance an existing FHA loan without the usual credit check and income verification. In some cases, you can also get an FHA Streamline refinance without an appraisal.
Your mortgage must already be an FHA loan in order to qualify for an FHA Streamline refinance, plus:
- You must undergo the usual credit check requirement if you want to refinance a conventional loan into an FHA loan or vice versa.
- You must also see a tangible net benefit after your refinance. A tangible benefit might be a lower monthly payment or a lower interest rate.
- Your monthly premium can’t increase by more than $50. If it does, you’ll need to conform to the full refinance standards.
- You can only have one 30-day late payment in the last year and none in the last 6 months.
3. VA IRRRL
You may also qualify for a VA Interest Rate Reduction Refinance Loan (VA IRRRL). VA IRRRLs allow you to refinance your loan with no credit check, income verification or appraisal. A VA IRRRL can offer you a quick way to refinance an existing VA loan.
Like an FHA Streamline refinance, VA IRRRLs have a number of specific criteria you must meet to qualify. You must already have a VA loan, you must have made at least six consecutive on-time payments and you can only refinance your rate or term, meaning no cash out. There also must have been at least 212 days from the date of your first payment on your existing VA loan to the date you refinance.
4. Cash-Out Refinance
One important thing to remember about refinancing without a credit check: You can only refinance your rate or term. You’ll need to have a minimum credit score of at least 620 if you want to take a cash-out refinance. This might be a “moderate credit” option for refinancing, but you can use the money to pay down additional debt which could further improve your credit score.
Mortgage loans have some of the lowest interest rates of any type of debt. The average fixed-rate mortgage loan has an APR under 3% as of this writing, and the average credit card has an APR of over 16%.
Taking a cash-out refinance and paying down what you owe can help you get back on track financially, particularly if you have a large amount of debt. You can consolidate your debt with one payment to your mortgage lender instead of worrying about missing payments across multiple cards. This can help you improve your score over time.
Tips For Improving Your Credit Score Before Refinancing
Take some time to raise your score (and check your credit report for inaccuracies) before you refinance. Raising your credit score unlocks more refinance options and can help you secure the lowest interest rate possible. Use these quick tips to improve your credit score.
Pay All Your Bills On Time
About 35% of your FICO® Score comes from your payment history, making it the single most important factor when it comes to building a great credit score. The fastest and most reliable way to improve yours is to build a solid history of on-time payments for each of your accounts.
Sit down with all of your bank, loan and credit card statements and figure out exactly how much you owe each month on all of your accounts. Write down each account’s minimum payment and due date in a spreadsheet. Remind yourself to pay each account on time every month by placing your spreadsheet somewhere you’ll run into it often, like on a desk calendar.
You may also want to enable automatic bill pay if your accounts offer it. Automatic bill pay allows you to schedule a date for your minimum payments in advance. From there, your account holders automatically deduct what you owe. This can help you avoid accidentally lowering your score by forgetting a payment.
Consider A Secured Credit Card
You might not qualify for a loan or traditional credit card. A secured card can allow you to build credit when you need to. You leave a deposit with your lender when you get a secured card. That deposit then becomes your line of credit.
For example, a lender might require a $500 deposit to open a card with a $500 limit. Your lender holds onto your deposit until you decide to close the card.
From there, a secured credit card works just like a normal credit card. You make purchases using your card and pay them off with interest each month. Then, your lender reports your payments to the credit reporting bureaus, which helps you build your score. Your lender keeps your initial deposit if you don’t pay your bills.
Secured cards offer a fantastic way to build credit when you might have none, but remember that you must still make your payments on time. Just like an unsecured credit card, missed or late payments will hurt your score.
Keep Your Credit Utilization Low
Credit utilization refers to the percentage of your total available credit that you use every month.
Let’s say you have a credit card with a $10,000 limit and you put $5,000 worth of expenses on it every month. In that case, you have a utilization ratio of 50%. If you use 100% of your available credit, you might hear someone say that you’ve “maxed out” your credit.
Lenders don’t like to work with borrowers who have very high credit utilization ratios. Using too much of your available credit tells lenders that you might not have anything in savings. It can also mean that you’re more likely to fall behind on your bills or miss a payment.
Keep your utilization ratio low month after month to raise your credit score. Your utilization ratio makes up about 30% of your FICO® Score.
Your score will generally increase if you keep your utilization ratio at or below 30%. For the biggest bump in your credit score, keep your utilization ratio below 10%. Carrying more cash with you, paying down your charges immediately and budgeting your money are all easy ways to lower your utilization.
Most mortgage lenders require a credit check before you refinance your property. However, there are limited ways that you can refinance with low credit.
Adding a non-occupying co-client to your loan allows your lender to consider both of your scores when they review your application. You can also choose a Streamline VA or Streamline FHA refinance, which allows you to refinance your rate or term without a credit check.
However, keep in mind that you cannot get a cash-out refinance with a credit score lower than 620 points. In some cases, it’s better to work on building up your credit score by making on-time payments and keeping your credit usage low before you refinance.
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