How to Refinance a Mortgage with Bad Credit

Learn the best strategies and loan options for refinancing your home despite a low credit score

Refinancing your mortgage is a great way to save money on payments or obtain extra cash by using your home's equity. Though refinancing can be more complicated if you have a low credit score, it's not impossible. It’s important to note that by refinancing your existing loan, your total finance charges may be higher over the life of the loan.

In this article, we'll discuss several ways that refinancing with bad credit can be feasible, as well as ways to improve your credit before beginning this process.

What Does It Mean to Refinance a Mortgage with Poor Credit?

When you refinance a mortgage, you essentially replace your current mortgage with a new one. Refinancing can be a valuable financial tool for homeowners because depending on the type of refinance loan, while your total finance charges may be higher over the life of the loan, a refinance may allow you to access cash, get better loan terms, eliminate mortgage insurance, and more.

Lenders tend to rely on credit score ranges to make approval decisions. Your credit score is a number from 300-850 that is meant to summarize your credit history in a single number. Lenders use your credit score as one indication of how likely you are to repay your debts. Below is a list of credit score ranges from FICO^® and, generally, how they relate to refinancing:

• Very Poor: 300-579. This credit score range makes it more difficult to get approved by lenders for refinancing, but at Freedom Mortgage, we can often accept a minimum score of 550 for FHA and VA cash out refinances. FHA and VA streamline refinances have even easier credit qualifications, and for non-credit-qualifying refinance transactions, we don't require a minimum credit score. FHA or VA streamline refinance borrowers, even those with what FICO characterizes as very poor credit scores, who have a history of making on-time payments, may still have their loan request approved.
• Fair: 580-669. The minimum credit score requirement for many conventional and USDA loan programs is 620 and above while FHA and VA refinances may allow credit scores well below 620 depending on your lender and the specific loan program you apply for.

The following three credit score ranges are typically acceptable to a lender for refinancing:

• Good: 670-739
• Very Good: 740-799
• Exceptional: 800-850

6 Ways to Refinance a Mortgage with Bad Credit

If your credit score is low enough that it limits your refinancing options, we've created a list of six ways that it can still be possible for you to refinance your mortgage.

1. Consider an FHA Refinance

There are three types of FHA refinances you may be eligible for.

• FHA streamline refinances: This is a simplified refinancing option for homeowners with an existing FHA loan. It requires minimal documentation and often no appraisal and is designed to lower your interest rate or monthly payment. FHA Streamline Refinances are often available as non-credit qualifying, making a strong payment history more important than your credit score. Credit qualifying streamline refinances for borrowers with good payment histories are often available with scores between 500 – 550 depending on the lender and other factors.
• FHA rate-and-term refinances: This option allows borrowers to refinance their existing FHA or non-FHA mortgage into a new FHA loan with better terms. It typically requires a home appraisal and income verification. FHA guidelines require a minimum credit score of 580 if your loan-to-value ratio is greater than 90%.
• FHA cash out refinances: This refinance allows homeowners to tap into their home equity and receive cash at closing, which can be used for expenses like home renovations, debt consolidation, and other financial needs. It requires a full credit check, income documentation, and a home appraisal. Like an FHA rate-and-term refinance, FHA guidelines require a minimum credit score of 580 if your loan-to-value ratio, is greater than 90%.

Freedom Mortgage can often accept a credit score as low as 550 for FHA cash out refinances. For non-credit-qualifying FHA streamline refinances, we don't require a minimum score to be reported, instead using recent payment history as a point of reference.

2. Explore VA Refinance Eligibility

If you're a veteran or active-duty service member looking to refinance your home, the U.S. Department of Veterans Affairs (VA) offers two main options. Each serves a different purpose and comes with its own set of requirements and benefits.

• VA IRRRL/VA streamline refinance: This is a simplified refinance option for veterans and service members with an existing VA loan. It's designed to lower interest rates or switch from an adjustable-rate mortgage (ARM) to a fixed-rate loan, with minimal paperwork and often no appraisal requirement. While the VA doesn't set a minimum credit score, lenders commonly require a score of at least 580 for this refinance option.
• VA cash out refinance: This loan allows eligible veterans to refinance their existing mortgage, whether it's VA or non-VA, and take out cash from their home equity. A home appraisal, full income verification, and credit check are required, and most lenders look for a minimum score of between 580-620.

Freedom Mortgage can often accept a credit score as low as 550 for VA cash out refinances. For non-credit-qualifying VA IRRRL/streamline refinances, we don't require a minimum score to be reported, instead using recent payment history as a point of reference.

3. Check Out a USDA Streamline Refinance

A United States Department of Agriculture (USDA) Streamline Refinance is a simplified refinancing option for homeowners with an existing USDA loan. It's designed to lower monthly mortgage payments with minimal documentation and no appraisal requirement for borrowers with lower credit, as the program emphasizes recent mortgage payment history over credit scores. This makes it easier for eligible homeowners to qualify even if their credit has declined since their original loan. By refinancing your existing loan, your total finance charges may be higher over the life of the loan.

4. Review Fannie Mae and Freddie Mac Refinance Options

The Fannie Mae RefiNow and Freddie Mac Refi Possible programs are designed to help borrowers with lower income and credit scores access more affordable mortgage refinancing that can lower monthly payments and interest rates. By refinancing your existing loan, your total finance charges may be higher over the life of the loan. They can be a viable option for borrowers with poor credit because they have more flexible credit requirements compared to traditional refinance loans.

To be eligible, a borrower must:

• Have a conventional loan owned or guaranteed by Fannie Mae or Freddie Mac that is at least 12 months old.
• Be current on their mortgage payments.
• Have an income at or below 100% of the area median income (AMI).

5. Consider Using a Co-Signer

Using a co-signer for a mortgage refinance may help you qualify for more favorable loan terms, especially if your credit score is low. A co-signer is typically a trusted family member or friend with good credit and a steady income. They're essentially a guarantor of your loan and reduce the lender's risk, potentially allowing for lower interest rates and eligibility for refinance options that would otherwise be unavailable.

Both you and the co-signer should understand the financial responsibility involved, since the co-signer becomes liable for the debt if the borrower cannot make payments.

6. Work with Your Current Mortgage Lender

One of your greatest resources when it comes to your mortgage is your mortgage lender. Lenders sometimes offer special refinancing programs or more flexible terms for existing customers, especially when rates drop. Since they already have a history with you, they may be more willing to work with your financial situation than a new lender would.

If you're looking to refinance your mortgage with less-than-ideal credit, we encourage you to reach out to us or your current lender.

How to Improve Your Credit Before Refinancing

As we've learned so far, many types of refinance transactions require a credit score of 620 and above. If you have a lower credit score, this number might feel out of reach, but there are a few simple ways that you can get your credit on the right track so you can refinance your home with less hassle.

• Monitor your credit. Check your credit report regularly to see how your score changes over time. This also allows you to look for and correct errors that may exist. When you check your credit report yourself, this is called a “soft inquiry” and has no effect on your score.
• Make on-time payments. Missing payments, especially after 30 days, can be detrimental to your credit score. Most institutions now have an autopay option on their websites or apps that ensures your mortgage, credit card, or other debt is being repaid when it should be. Having a consistent on-time payment history will help boost your credit score.
• Pay down high-interest debt. Paying down high-interest debt is vital to both maintaining a good credit score and preventing yourself from falling into even more debt through accruing interest. Credit card debt has one of the highest interest rates and can sneak up on you if you're not paying attention to how much you owe.
• Use credit modestly. If you use too much of your monthly credit limit, it can have a negative effect on your credit score. Your credit utilization ratio, which is the percentage of your available credit that you use, should be kept under 30%. If you can manage to only use this amount or less of your available credit and continue to make on-time payments, it can significantly boost your credit score.

Pros and Cons of a Mortgage Refinance with Bad Credit

Although refinancing your mortgage can offer several financial benefits, it's important to consider the potential advantages and drawbacks to determine if it's the right move for your situation if your credit isn't in the best spot.

Pros

• Access to equity: Cash out refinancing may allow you to tap into your home's equity for extra cash that you can use for a variety of purposes, such as re-investing it into home improvement projects to increase your home's value.
• Better loan terms: You may be able to get lower rates and more flexible repayment options on your new loan that can save you money in the long run.
• Lower monthly payments: If you can qualify for a lower interest rate or extend your loan term, you might be able to decrease your monthly mortgage payments.
• Fixed rate conversion: You can switch from an adjustable-rate mortgage (ARM) to a fixed-rate loan for more stability.

Cons

• Higher overall costs: By refinancing your existing loan, your total finance charges may be higher over the life of the loan.
• Higher interest rates: Lenders typically charge more interest if your credit score is low, potentially offsetting the benefit of refinancing.
• More limited options: Fewer lenders may be willing to work with you, reducing your negotiating power.
• Closing costs: Costs associated with refinancing, such as appraisal, title fees, and loan origination can be expensive and could outweigh potential savings.

FAQs About Refinancing a Mortgage with Bad Credit

In this section we'll cover some frequently asked questions about refinancing a home with bad credit. It may also be a good refresher of the topics we've covered so far in this article.

Can I Refinance My Mortgage if My Credit Is Bad?

The short answer is yes! The long answer is also yes, but it can present some challenges and come with higher interest rates. Some lenders offer specialized programs for their existing customers with low credit scores, and there are government-backed programs like FHA or VA refinances that may be an option for some borrowers. Improving your credit beforehand or adding a co-signer can help you qualify for better loan terms.

What's the Lowest Credit Score Required to Refinance a Home?

The lowest credit score in the industry required to refinance a home really depends on the type of loan program you select and your lender. FHA and VA loans often allow for the lowest scores while conventional and USDA loans typically require a minimum score of 620. However, here at Freedom Mortgage, we can often accept a minimum score of 550 for FHA and VA cash out refinances, which may be lower than other lenders. For non-credit-qualifying FHA or VA streamline refinances, we don't require a minimum score, but you should have an excellent payment history over the last 12 months.

Does Refinancing Affect My Credit Score?

When you refinance, your new loan will be reflected in your credit reports and can cause your score to dip down. However, this will be very temporary if you continue to make on-time debt repayments.

When you apply for a new loan to refinance, a lender looks at your credit history, resulting in a “hard inquiry” which will show up on your credit report for up to two years, but typically only affects your actual score for one year. You can reduce the number of hard inquiries on your report by researching lenders and rates and only selecting a few to apply to. You will also have a window of time after the first application to apply to others without them counting as additional hard inquiries.

Final Thoughts on Refinancing with Bad Credit

In summary, refinancing with bad credit is possible, but there are some potential hurdles. It's important to consider if any of the options discussed in this article are a good fit for you, whether that's going forward with a refinance now or building a better credit score first. Talk to one of our lenders to get started with a refinance and explore your options today.