Refinance Your Home Loan with Bad Credit: Is It Possible?

Last Updated: August 21, 2019
Advertiser Disclosure

Our content may include links to products from our partners

It's not a secret - lower credit scores show that you have a higher risk of not making payments. Therefore, refinance your mortgage with bad credit can be a difficult task. The good news - sometimes, it's still possible. We have summarized the most important things you should know.

If you own a house and have a good credit score it can be a great idea to refinance your mortgage. That’s especially true if your score has improved since you originally got that mortgage. You may be able to get lowered interest and payments, which is going to mean less overall cost to you over time.

Of course, if your credit score isn’t that great … it’s not such a great option. At least, not all the time, especially if you have a lower score than you did.

If you have bad credit you may not be able to refinance, but it’s something to consider. After all, you want to lower your interest rate, lower your payment or anything else and that might require you to have a specific type of lender, who specializes in financing for people with bad credit.

What Score Do I Need to Refinance?

If you’re looking to refinance you need to know what you’re looking at for your credit score. Most of your score is going to be about your payment history and the total amount of debt that you have. If you have a problem with those two things you’re going to look like a high risk. That means the mortgage lender that you’re going through will likely charge you even more in interest. That’s because they consider you more of a risk to them and they don’t want to loan you the money if they can’t be sure that it’s going to be paid back.

Someone who has a credit score of 800 may get 3.5% interest. Someone with less than a 650 could get up to 4.5% interest. Just that one percent could be the difference between tens of thousands of dollars.

If you’re looking to qualify for a conventional, fixed-rate home loan you’re definitely going to need a 620 credit score. If you’re looking for an FHA loan, through the Federal Housing Administration, you need something at 580 or above. When it comes to refinancing however, you’re going to need a 620 as the cutoff, which is considered ‘poor.’ Of course, there are other factors that are considered when it comes to refinancing. The lender will look at your current equity, the current mortgage, your savings, your debt, our debt-to-income ratio, and your loan-to-value ratio.

Improve Your Credit Score

If you have a higher credit score you’re likely to get a lower interest rate. Plus, you’re going to have a better chance of actually getting that refinancing. In order to start the process of increasing your score, you’ll need to go to annualcreditreport to get a free copy of your report from each of the bureaus. Make sure you look for any type of errors and that you get them fixed immediately. They make the process relatively easy to apply for though it may take time to get things done.

As you continue the best thing you can do is pay everything on time. Whether that means you need to set up automatic pay or create yourself some reminders, you’re definitely going to need to get those payments in. Plus, make sure you don’t get a lot of credit all at once and that you get rid of as much debt as you possibly can. This is even more important if you have a high debt-to-income ratio.

Those who have very bad credit are going to struggle to get a credit card and will struggle to show their worthiness to a lender.

If that’s the case, a secured credit card could be your answer. You’ll only be able to make purchases that are at or below the amount that you keep in a specific account. There will be interest if you don’t pay it off each month, however.

Check Alternative Lenders

There are lenders that don’t look at your credit score but instead look at things like your cash flow, your income and your employment history. SoFi is one of these types of lenders. Other methods include using someone else who has high credit to help you out. You could also use information like utility bills and payments, memberships and other methods of proving that you pay your bills on time.

Keep in mind that not all lenders are going to deny your application just because one of them did. You may be able to find someone that will still give you a loan, especially if you go to someone who specializes in low-credit loans.

Talk to Your Lender

If you’re thinking about getting a refinance you want to make sure you talk with your lender first. If you’ve been a great client all this time and providing on-time payments as well as getting a better credit score you could find that your lender is willing to work with you. They might be willing to refinance just so you stay with them.

No matter what your credit is, you want to make sure you give your lender a chance.

Don’t assume that you’re going to be refused just because you have bad credit. If you have on-time payments to show you might be able to show that you have become a lower risk and that you deserve the refinancing you’re looking for.

The bank you work with wants to keep you because they want the money that you’re bringing in. If they can help you out with refinancing and keep you with them rather than losing you to someone else, they’re more likely to do what they can.

Of course, that doesn’t mean that every lender you work with is going to help you. But it does mean that you’re not missing out on anything just by trying. Of course, keep in mind that you’re going to need to shop quickly if you have a lender that does a hard inquiry on your report. If you get the inquiries done within a short period they count as a single inquiry to the credit bureau and your credit score.

Get a Co-Signer

If you have a family member or a friend or a partner that is willing to help you out, look for a co-signer. If they have a higher credit score the lender might feel more confident in giving you a loan. They may feel like there’s less of a risk that you won’t make your payments.

Of course, you need to show that the co-signer has better credit than you do and that they’re financially stable. They also need to understand that they’re responsible for your loan if you don’t pay it.

Drop the Debt

Your debt-to-income ratio is super important when it comes to a mortgage refinance. This is the amount of your total monthly payments divided by your monthly income.

You can check out this ratio in one of two different ways. A front-end ratio considers your total housing costs and divides them by your monthly income. Your payment on the loan, including principal, interest, property tax and mortgage insurance, are added to your homeowners insurance and HOA fees to determine your debt-to-income ratio. In general, 28% or less is ideal for conventional loans and 31% or less for FHA loans.

Another method is a back-end ratio. In this method, it’s your monthly debt payments divided by your total monthly income. Everything that you pay out, including housing costs, child support payments, credit card payments, car loans student loans and more are all considered. You should have a 33% or lower debt-to-income ratio for conventional loans and 45% or less for FHA.

Keep in mind that this ratio is not the same as the utilization rate that is used in your credit score. That considers your credit card debt to limits. Still, improving your credit score is going to be extremely important before you decide to refinance and that includes your general credit utilization rate.

By decreasing your balances on your credit cards you’ll have a better credit utilization score and that’s going to improve your debt-to-income ratio.

Cash it Out

If you have equity built into your home you could consider this option while refinancing. With cash-out refinancing, you actually get a new loan that will pay the old one and give you the difference. You don’t get the full amount that you’ve paid in, but you’ll get a decent amount, depending on what you’ve paid. The difference between the total balance and 80% of your home’s value will be paid out to you and that can help you pay even more debt that you might have.

You’re going to get a full new mortgage rather than a home equity loan. You want to make sure you negotiate with your lender to discuss closing costs and decrease your loan.

For those who have an FHA loan, there is an FHA Cash-Out Refinance. This program works for those who have a credit score of 580 or higher. It may be difficult to get a loan if you are lower than a 600 credit score, however. With this FHA program, you have to have an LTV of 85% or less, which means that someone who doesn’t have a lot of equity will not be able to get anything. At least 15% of equity is required for this type of program.

FHA Streamline Refinance

For those who have an FHA loan right now, there is the possibility for an FHA streamline refinance. With this type of refinancing you don’t actually have to verify things like your assets and your income, which makes it different from the traditional refinance that you’ll find. It makes the entire process a whole lot easier for anyone who is looking to apply for the refinance.

When it comes to this type of refinancing you also don’t have to worry about a minimum credit score. Make sure you look around at different lenders to find what works best for you and fits your current standards. You will have a credit check before you get approved even for this FHA refinance. For most lenders, though the FHA doesn’t have requirements, you’ll need at least a 640, but some will go as low as 600. With thee programs even people with VA and USDA loans can get a streamline refinance.

If you’re looking at the difference between a Simple Refinance and a Streamline Refinance you should take a look at the features. A simple refinance is going to require a credit qualification process. And both of these can be great benefits to a potential borrower. With a streamline refinance you’re better off if your home is not very different in value now than it was previously or if you’re planning to sell it soon. With a simple refinance you get to keep your costs low and you may get lower interest if you have equity. It’s really going to depend on your specific situation and what you want in the long-term but a loan officer should be able to help you.

With a Cash-Out Refinance, you’ll get potentially more than the $500 limit that you’ll have with the other types.

Bottom Line

When you’re looking to refinance and you have bad credit it can be difficult, but that doesn’t mean it’s impossible. Just make sure you look at why you’re trying to refinance. If your credit score has gone up or interest rates are going down it might be a good time to refinance.

If you think that it’s a good time then you should talk with your lender right now before you try shopping around. Make sure you do shop around a bit though before you decide to go with anyone in particular. You’ll want to know about different fees and terms before you decide to go with anyone.

Make sure you look at improving your credit score before you start looking to refinance.