Options For Refinancing Your Home With Bad Credit

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Casey Bond,

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Updated: Dec 15, 2021, 5:00am

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Options For Refinancing Your Home With Bad Credit

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With today’s low mortgage rates, you might be hoping to save some money by refinancing your mortgage. But like a lot of people who took on more debt during the Covid-19 pandemic, your credit score may have taken a hit recently. This can affect your ability to refinance your mortgage, and the interest rate the lender is willing to offer you.

Although it’s not impossible for borrowers to refinance homes with bad credit, it does take more legwork. In fact, sometimes you can refinance with a score in the 500s. So if you’re hoping to refinance a mortgage with bad credit, learn your options below.

4 Steps to Refinance Home With Bad Credit

There are several different ways to refinance your home loan with bad credit, including working to build up your credit score first. However, if you don’t have time or the money to raise your score, here are some more immediate steps you can take to refinance your mortgage.

1. Work With Your Existing Lender

When looking into a bad credit home refinance, your first step should be talking to your current lender to find out what type of deal you can work out. As an existing customer, you may receive a bit more leeway in terms of credit qualifications, especially if you’ve been a good customer and made all your payments on time. Your lender would probably rather keep your business.

Even if your current lender agrees to a refinance, it’s a good idea to gather quotes from several other financial institutions to be sure you’re getting the best deal possible. If you go this route, however, submit all your applications within a period of 45 days because FICO will recognize it as rate shopping and therefore, won’t ding your score for several hard credit inquiries within that short timeframe.

2. Check VA Refi Program

If you’re a servicemember, veteran or qualifying spouse, you may be able to refinance with a loan backed by the U.S. Department of Veterans Affairs (VA). These loans are provided by private lenders but insured by the VA so that borrowers can more easily qualify and at a lower cost. Though the VA doesn’t institute a minimum credit score requirement, the individual lender might require a score of at least 620.

You have two options for refinancing with a VA loan.

VA streamline refinance. If you already have a VA mortgage loan, you could refinance through the more streamlined VA Interest Rate Reduction Refinance Loan (IRRRL) program. The VA doesn’t require you to go through a new credit check or appraisal, but the lender might. One requirement to qualify is that it would produce a “net tangible benefit,” such as lowering your fixed interest rate by at least 0.5%.
VA cash-out refinance. Whether you have a conventional loan or existing VA loan, the VA cash-out refinance is another option. Though you can tap into your home equity and pull out cash with this refinance, you aren’t required to do so.

3. FHA Refi Programs

Another government-backed refinancing option is to go through the Federal Housing Administration (FHA). Loans backed by the FHA typically have less stringent requirements and allow borrowers to qualify for refinancing with scores as low as 500, depending on the program.

FHA streamline refinance (credit-qualifying). The streamline refinance program allows FHA loan borrowers to refinance with less paperwork involved. A credit-qualifying refinance means the lender does have to run a credit check and verify your debt-to-income (DTI) ratio, however. There must also be a net tangible benefit to refinancing. If you refinance within three years of the original FHA loan closing, you might get some of your mortgage insurance premium refunded.
FHA streamline refinance (non-credit-qualifying). This option usually doesn’t require income verification, a credit check or an appraisal. You must show that you’ve made your last three mortgage payments on time, and you can only be more than 30 days late on one payment if your mortgage is older than 12 months. This non-credit-qualifying version doesn’t require a specific credit score minimum in order to be approved. However, the tradeoff is that you may pay a higher interest rate.
FHA rate and term refinance. Unlike the streamline programs, the FHA rate and term refinance option does require a formal credit check, with a minimum score of 500-580, depending on your loan-to-value (LTV) ratio. However, you don’t need to have an existing FHA loan to apply. You will still need to show that your last 12 consecutive mortgage payments were made on time and in full.
FHA cash-out refinance. If you want to tap your home equity and use the cash to pay down high-interest debt or make home improvements, for example, the FHA cash-out refi program may be a good choice. You can borrow up to 80% of your home’s value with a credit score of at least 500 (though certain lenders may require higher scores).

4. Find a Co-signer

Another option is to have a trusted family member or friend with good credit co-sign on your loan. If you were unable to make your payments, the co-signer would be legally responsible for the debt and the lender could pursue them for the funds. Missing payments will also harm the co-signer’s credit. So if you pursue this route, understand that it can have major implications for the person who co-signs. Be sure everyone understands the terms of the loan and agrees to the risk.

Improving Your Credit Profile

If you’re unable to qualify for a mortgage right now, consider spending some time working on improving your creditworthiness and applying later. There are several steps you can take to become a more attractive borrower in the eyes of lenders.

Check Your Credit Score and History

Start by pulling your credit reports from each of the three major credit bureaus: Experian, Equifax and Transunion. You can get a free weekly copy of each at AnnualCreditReport.com until April 20, 2022; after that, you can get one free copy from each bureau every year. Review your report for any errors that may be dragging down your score. If you find one, dispute it with the bureau that’s reporting the mistake. You can do this online.

Also check to see what types of negative items could be holding down your credit score, such as past due payments or accounts in collections. Getting your accounts in good standing and continuing to pay all your bills on time will help your credit improve greatly, as payment history accounts for 35% of your score.

Related: How To Check Your Credit Score

Build Your Savings

If your credit isn’t in great, one way to improve your chances of being approved for refinancing is to build up your savings. A larger down payment and/or extra cash reserves can help offset the risk you present as a borrower.

Lower Your Debt

Another important metric that lenders consider is your DTI ratio. This measures how much of your monthly income goes toward paying debt obligations. Though some lenders will allow a DTI of up to 50%, keeping yours lower—ideally under 43%, including your potential mortgage payment—will help improve your chances of getting approved.

When to Refi With Bad Credit

Refinancing your mortgage when you have bad credit may be more difficult than if you had good credit, but it’s still possible. And it may be worth pursuing in some cases. It comes down to crunching the numbers and making sure you come out ahead.

For instance, if you have a high mortgage rate, refinancing to a lower rate could save you thousands of dollars over time. Just be sure to factor in any closing costs and determine your break-even point, which is typically around three to five years. If you plan to move before that time, refinancing may not be worth it.

Related: Mortgage Refinance Calculator

Another situation when refinancing may be a good idea is when you can lower your monthly payments, freeing up cash to pay down other higher-interest debt. Eliminating mortgage insurance is another smart reason.