Refinancing Your Mortgage With Bad Credit

Mortgage Dove

Refinancing Your Mortgage With Bad Credit

Mortgage refinancing involves obtaining a new loan to replace your existing home loan, resulting in changes to the loan's term, interest rate, or principal balance, or even a combination of these adjustments. The process of refinancing entails settling your old loan using the funds from the new loan and subsequently making payments based on the terms of the new loan.

Your credit score plays a significant role in whether you’ll meet the requirements to refinance. Some lenders might be unable to provide you with a loan should your score fall below 620. Refinancing may take even longer if you have a bankruptcy in your history in addition to your low credit. Up next are three options for refinancing with a credit history that’s less than ideal.


Options For Refinancing With A Bad Credit History

Apply With A Non-Occupying Co-Client

You have the choice of pursuing a refinance with a non-resident co-borrower. This refers to an individual who doesn't reside in your home but is prepared to assume financial responsibility for your loan in the event of a default.

In this situation, your lender considers both parties' credit score, income, and assets when they underwrite your loan. Depending on the type of loan you get, your co-signer may also need to be on your home's title.

Typically, your qualification hinges on the lower median credit score when you're applying with a co-client. While having a co-client can be beneficial for reducing your debt-to-income ratio (DTI), you'll still need to meet a minimum credit score requirement. However, there's an exception with conventional loans supported by Fannie Mae, as the lender considers the average of the applicants' median scores as the qualifying score.

Applying for a refinance with a co-client can boost you, but remember the strings attached. If you fail to repay your loan, your refinance provider can pursue your co-client for the money. Ensure you can handle your monthly payments before applying for a refinance – and maintain a great relationship with your co-client.


FHA Streamline Refinance

This option allows you to refinance an FHA loan without the usual credit check and income verification. Sometimes, you can also get an FHA Streamline Refinance without an appraisal.

To be eligible for an FHA Streamline Refinance, your current mortgage must already be an FHA loan. In addition:

  • You must undergo the usual credit check requirement to refinance a conventional loan into an FHA or vice versa.
  • After refinancing, you must see a tangible net benefit. A tangible benefit might be a lower monthly payment or interest rate.
  • Your monthly payment can’t increase by over $50 if it’s a term reduction of 3 or more years. If it does, you must conform to the complete refinance standards.
  • You can only have one 30-day late payment in the last year and none in the previous six months.


Cash-Out Refinance

One essential item to remember about refinancing without a credit check: You can only refinance your rate or term. In most scenarios, you’ll need a minimum credit score of at least 620 if you want to take a cash-out to refinance.

While it may fall under the category of "moderate credit" for refinancing, the funds can be utilized to reduce existing debts, potentially contributing to an enhanced credit score.

A cash-out refinance and paying down what you owe can help you get back on track financially, particularly if you have a large debt. You can consolidate your debt with one payment to your mortgage lender instead of worrying about missing payments across multiple cards. It can help you improve your score over time.


Should You Refinance With Bad Credit?

You might wonder if you should refrain from refinancing if you have bad credit. If the opportunity for refinancing is available to you at this moment, it's certainly something worth contemplating. But why, you ask? Well, because it could potentially be a pivotal move in the transformation of your not-so-great credit into a much-improved one.


Benefits of Refinancing

If refinancing makes sense for you, then you might reap some of its benefits, which include:

  • Reduce your payments

By refinancing to secure a lower monthly mortgage payment, you'll have more financial flexibility to tackle other debts or bolster your savings.

  • Say goodbye to mortgage insurance

Should your refinancing process entail a fresh home appraisal, you might discover that your home's value has appreciated, potentially allowing you to eliminate mortgage insurance costs. Suppose the matter has risen to the point where you now have 20 percent equity. In that case, you might be able to stop paying mortgage insurance expenses.

  • Save money in the long run

Lowering your interest rate or shortening your loan term can save you money in the long run.


Drawbacks of Refinancing

While refinancing your mortgage may offer benefits, there are also costs associated with the process, and you may only sometimes obtain a better interest rate. These are the following drawbacks:

  • Closing costs

Similar to obtaining your initial mortgage, you must pay closing costs when refinancing. Depending on where you live, closing costs can be steep, amounting to thousands of dollars out of your pocket.

  • Longer loan term

When you opt for refinancing, it essentially means hitting the reset button on your loan repayment schedule. So you’ll be in debt longer.

  • Credit score impact

Mortgage refinancing entails a thorough review of your credit profile, involving a hard inquiry. This temporary dent in your credit score can typically lead to a reduction of approximately five points. Moreover, the refinance process involves closing your existing mortgage to initiate the new loan, which can impact your credit score as well. In turn, this affects your credit history, and credit history accounts for about 15 percent of your overall score.


How to Improve Your Credit For a Refinance

As you consider your options to refinance with bad credit, it’s essential to consider improving your credit score. Boosting your credit score opens up a world of opportunities. You can enhance your credit rating through three key methods:

  • Check your credit report

Through the end of 2023, all three major credit reporting bureaus — Experian, Equifax, and TransUnion — will provide you with one free credit report per week. While the reports won’t give your credit score, they’ll detail all your debts and payment history, impacting your score. 

  • Reduce your credit utilization ratio

Your credit utilization ratio measures the total amount of available credit you’re using. Reducing it by paying down the balance on your revolving lines of credit can significantly impact your score, as it accounts for 30 percent.

  • Pay all bills on time

Your payment history is the most significant factor contributing to your credit score. It makes up approximately 35% of your total score. Consistently paying bills on time without fail can have a substantial impact on improving your score.


Next Steps on Refinancing With Bad Credit

If you want to refinance and have bad credit, the first step is to improve your credit score. This involves ensuring that you consistently make punctual payments, reduce outstanding debts, and gradually construct a positive credit history. 

If you have an FHA, VA, or USDA loan, consider whether a streamlined refinance is an option. For those considering a cash-out refinance, it's essential to be aware that you will typically require a minimum credit score of 580 for an FHA cash-out refinance, while most other cash-out refinances may necessitate a credit score of 620 or higher. Otherwise, explore your options and see if refinancing right now is your best financial choice.

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