Refinancing a Mortgage With Bad Credit

If you've been putting off trying to refinance your home loan due to credit issues, you might be in luck. Mortgage refinancing options exist even for those with bad credit.

Key Takeaways

  • If you have a high-interest rate or must carry mortgage insurance, you may want to refinance your home loan even if you have bad credit.
  • There are a few options to get approved for a mortgage refinance when you have less than stellar credit.
  • Depending on your situation one of these options may benefit you: a non-occupying co-client, an FHA streamline refinance, a cash-out refinance, or a VA interest rate reduction refinance for those with a VA loan.

Why Refinance?

When you refinance, you essentially take out a new mortgage that pays off your old one. You may want to do this to change the terms of the loan, get a better interest rate, or drop mortgage insurance. (If you put less than 10% down on your home or have an FHA loan, you’re required to carry mortgage insurance until you have 20% equity built up in your home. Then you can refinance to drop the insurance.) You may also want to take a cash-out refinance loan and use the extra money to pay off debt or improve your home.

You apply for a refinance loan the same way you did for your original mortgage. You choose a lender, check if you meet their qualifications, and fill out an application for the loan. You’ll typically need all your supporting documents like bank statements and paystubs. You’ll also likely need to get a home appraisal.

Refinancing With Bad Credit

Though your credit score is an important part of qualifying for a refinance loan, some options could help in this situation.

Apply With a Non-occupying Co-client

Just like a co-signer on a car or personal loan, a non-occupying co-client is someone who doesn’t live in your home but is willing to take a chance on you as your co-borrower. This could be a parent or grandparent. Essentially, they’re also taking responsibility for the loan if you fail to make the payments. The reason a co-client helps is because lenders look at both of your credit scores and count your co-client in your income-to-debt ratio.

Though your co-client may have a great credit score, you’ll still have to meet the minimum credit score requirement for your lender to qualify. But having a co-client could give you the needed boost to qualify for the loan. Make sure your co-client understands fully that they’re also responsible for the loan along with you.

Get an FHA Streamline Refinance

 If you have a current FHA loan, this option could allow you to refinance it more easily. With a streamline refinance, you won’t need as many documents, you may not need a new appraisal, and the requirements to qualify are more lenient, including the credit score.

If your current loan is not an FHA loan, you won’t be able to use this option. However, if it is, you can qualify for a streamline refinance if you meet these qualifications:

  • You’ll still have to have a credit check and get approved. 
  • You’ll need to have a tangible net benefit after your refinance. For example, a lower payment, a lower interest rate, or better terms. 
  • Your monthly payment can’t increase by more than $50 with the new streamline refinance. If it does, you’ll need to qualify for a full refinance loan. 
  • You can only have one 30-day late payment in the past year and no late payments in the past six months to qualify.

Take Out a Cash-out Refinance

Most lenders require at least a 620 credit score to take a cash-out refinance loan. If you qualify, you may be able to use the equity in your home to pay off additional debt. For instance, if you owe $185,000 on your mortgage but your home is valued at 230,000, you may be able to refinance for a larger amount like $200,000. That amount would pay off your old loan and provide you with $15,000 cash to pay off other debt to help your overall financial situation.

Since mortgage debt typically costs significantly less to finance than high interest debt, like the amount owed on a credit card, consolidating your debt and rolling it into your mortgage can make a lot of sense.

Try a VA Rate Reduction Refinance Loan

As with an FHA streamline refinance, the VA has an interest rate reduction refinance loan (IRRRL) for people who have a VA loan. Again, most lenders require a 620 credit score, but if you qualify and have a VA loan, this refinance can save you money. Just like with other refinance programs, you must meet certain requirements to qualify for the VA IRRRL:

  • You must have a VA loan.
  • You must have made the last six consecutive mortgage payments on time.
  • You can't take cash out with this refinance.
  • There must be at least 210 days from the first payment of your original loan until your refinance.

Use a USDA Refinance Loan

Similar to a VA or FHA streamline refinance, if you hold a USDA mortgage, you may be eligible for one of the USDA's refinance loans. These include non-streamlined, streamlined, and streamlined assist. Note, these are not cash-out refinance loans and can only be used for 30-year fixed, USDA mortgages.

How Many Times Are Your Credit Scores Checked When Refinancing?

Your credit scores are pulled once at the beginning of the process and then a second time toward the end of the process. This is to ensure that you did not take out any additional loans or credit cards during the process.

Will Refinancing Hurt My Credit Score?

While taking additional credit and increasing your credit balance does lower your credit score, when you refinance, you replace one loan with another, so the dip in your credit score may be minimal.

Can I Refinance Immediately After Closing?

In some cases, you may be able to. In others, you may be required to wait from six to 24 months, depending on the lender, before you're eligible to refinance. Refinancing is typically done to receive a better term or interest rate so it would also be unlikely that you would close with one lender only to immediately refinance with another that would give better terms.

The Bottom Line

Even if you have substandard credit scores, there are still a few options to refinance a higher interest rate loan, get a better interest rate, a lower payment, get cash out to pay off debt, or be able to drop your mortgage insurance. All these things can put you in a better financial position. Check with your preferred lenders to see if you might qualify for any of these refinance loans.

Article Sources
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  2. Fannie Mae. "Non-Occupant Borrowers."

  3. Housing and Urban Development. "Streamline Your FHA Mortgage."

  4. Rocket Mortgage. "FHA Streamline Refinance: Pros, Cons And Rates."

  5. U.S. Dept. of Veterans Affairs. "Interest Rate Reduction Refinance Loan."

  6. Federal Deposit Insurance Corporation. "Interest Rate Reduction Refinance Loan," Pages 1-2.

  7. JDSUPRA. "Why Ginnie Mae Issuers Are Challenging VA Seasoning Buyout Demands And Why Lenders Care."

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