Learn How to Refinance With Bad Credit
Refinancing your mortgage can come with a number of possible benefits, from lowering your interest rate and reducing your monthly payments to getting cash for a major renovation. Your credit score is an important factor lenders consider when determining whether and how to work with you on a refinance, and bad credit could put you at a disadvantage compared with other borrowers.
Interest rates have been climbing over the last six months — in fact, data from Freddie Mac shows that 30-year fixed rate mortgages are hovering around a three-year high. Although refinance rates may still be favorable for many homeowners, they shouldn’t be the only factor in your decision.
If your credit is less than stellar, you may have trouble qualifying for a lower interest rate in the first place, as lenders offer their best rates to low-risk borrowers who have higher credit scores. Conventional mortgage lenders require a score of at least 620 for approval and some may have even stricter minimums.
It is still possible to refinance a mortgage with bad credit, however. Here are some options to consider for a bad credit refinance.
7 ways to refinance a mortgage with bad credit
- Work with your current lender
- Shop around for the best deal
- Work to improve your credit score
- Get a cosigner
- Use an FHA Streamline Refinance
- Streamline with a VA Interest Rate Reduction Refinance Loan (IRRRL)
- Apply for HARP
Work with your current lender
The first step is to talk to your original lender. If you have a history of on-time payments and are current on your loan, they may be willing to work with you despite your credit. A low score won’t necessarily make or break your application, as lenders also look at your loan-to-value (LTV) ratio, your debt-to-income ratio and your current employment and income. At the very least, you’ll have something to compare with other lenders.
Another reason to keep your mortgage with your current lender if they offer a competitive rate: you may avoid incurring additional costs to transfer and set up a new escrow account used to pay property taxes and insurance fees with your new lender.
Shop around for the best deal
Your credit helps lenders decide whether to work with you, and it also impacts your interest rate. Compare rates at different lenders to find the best deal. Some are more willing than others to work with borrowers who have lower credit scores, so you’re likely to find a range of options. Your interest rate depends on a number of factors, including your credit score, the type of loan and the terms — as you price-shop, ensure you are comparing similar options. You can compare refinance offers on LendingTree.
Comparison shopping can significantly impact what you pay over the life of your loan. According to a recent LendingTree Mortgage Rate Competition Index, shopping for the lowest rate could save homebuyers more than 10% of their loan amount in interest on both purchase and refi loans.
For example, say one lender offers you a 30-year, $2500,000 loan at 4% interest. With a $1,193.54 monthly payment, you’ll spend $429,674.40 over your term. If another lender offers you the same amount and term at 3.5% interest, your monthly payment will drop to $1,122.61 and your total to $404,139.60 — a savings of $25,534.80.
Work to improve your credit score
If poor credit means you are offered unfavorable rates and terms, or that you struggle to find a lender, consider working to improve your score first. As we said, conventional lenders look for a minimum score of 620. Start by collecting your credit reports and disputing any errors, as this will provide the quickest score boost.
Once you’ve addressed errors, take a look at your spending habits. Pay your bills on time — this is the most important component in both the FICO and VantageScore models, and a history of missed payments can drag your score down. Keep your credit utilization low, avoid opening new accounts if possible and work to pay down outstanding debt. You won’t see the impact of these changes immediately, but with consistent focus over time, your score will improve.
Get a cosigner
A cosigner can help you qualify for a loan and/or a better interest rate than you can get on your own, especially if you have bad credit. This person will be held financially responsible for your refinance if you miss payments, which means his or her credit is also at risk. This is a big commitment and not something you or your prospective cosigner should take lightly.
Use an FHA Streamline Refinance
The FHA Streamline Refinance program allows homeowners who already have an FHA-insured loan to refinance with limited underwriting and scrutiny of your credit score. This means you likely won’t have to do a credit check, verify your income or employment or go through an appraisal process. You can also expect lower closing costs than you’d find elsewhere. Though these loans are made by private lenders, your ability to meet the FHA’s standards for your initial mortgage makes you a safer bet in spite of your credit.
To be eligible for an FHA Streamline Refinance, you must already have an FHA loan and be current on your mortgage payments. You must also demonstrate a tangible benefit of refinancing: a lower interest rate, a lower monthly payment or a switch from an adjustable-rate mortgage to a fixed-rate mortgage. With an FHA refinance loan, you cannot do cash-out in excess of $500.
Streamline with a VA Interest Rate Reduction Refinance Loan (IRRRL)
If you are a service member or veteran with an existing mortgage backed by the U.S. Department of Veterans Affairs (VA), you may be able to go through a streamline refinance for a new VA loan. Similar to an FHA Streamline Refinance, an IRRRL doesn’t require extensive documentation or credit scrutiny. Although the VA does not limit how much you can borrow, it will only insure a certain amount — your loan is actually financed by a VA-approved lender. This cap depends on the county in which you live.
The eligibility requirements for an IRRRL are similar to an FHA refinance — in addition to being a service member or veteran, you must be current on your mortgage, have no more than one late payment in the last 12 months and demonstrate a benefit to the refinance. An IRRRL cannot be cash-out, which is a type of refinance where you borrow more than you need and are given the difference in cash.
Apply for HARP
If your loan originated on or before May 31, 2009, you may be eligible for refinancing through the Home Affordable Refinance Program (HARP). HARP was designed specifically for homeowners with high (80% or more) LTV ratios who want to refinance into a more affordable loan. The program is intended to help borrowers who have limited equity in their homes or who owe more than what their homes are worth to lower their monthly payments, shorten their loan terms, receive lower interest rates or switch from adjustable to fixed rates.
There’s no minimum credit score to apply for HARP. Like the FHA Streamline Refinance program, HARP requires less paperwork and underwriting and comes with low closing costs. To qualify, your mortgage must be owned or guaranteed by Freddie Mac or Fannie Mae, and you must be current on your payments in addition to the origination date cutoff and LTV requirements.
The deadline to apply for a HARP refinance has been extended to Dec. 31, 2018. Check with your current lender to find out if they participate in HARP — if they don’t, you could still take advantage of the program with a new lender.
Even if you qualify for a lower interest rate, a refinance may not save you money in the long run. The process with most conventional lenders will be similar to obtaining your initial mortgage, which means you’ll pay closing costs — application, appraisal, and attorney fees, to name a few — all over again. Before you go through with a refi, calculate how long it will take to recoup these added costs. If you don’t plan to stay in your home long term, for example, the upfront expense may not make sense and could even damage your credit further if you are unable to make your payments.
If a refi lines up with your financial situation and goals, and you don’t currently qualify for any of the above options, don’t give up. Actively work to boost your credit and try again once you’ve improved your score.