Refinancing your mortgage can be a great way to save money or get more favorable terms on your home loan.
This is especially true if interest rates are low and your home value has increased since you bought your home.
But what if your credit score is standing in the way of refinancing?
When you first bought your home, lenders may have been happy to accommodate a credit score in the 620 to 700 range.
But when the housing market is hot and applications are pouring in, lenders can afford to be choosy and set their credit score floor at 700.
Suddenly, refinancing your mortgage with bad credit or even less-than-perfect credit can become a bad headache.
Refinancing a Mortgage With Bad Credit: Still an Option
If lenders offer you a mortgage refinance (aka a “refi”) with a low credit score, you may be stuck with higher interest payments and less favorable loan terms for the long haul.
But, you might still benefit from a refi if you can …
- Lower your interest rate: You can save money with a 0.5% interest rate reduction, but a refinance is more valuable if you can lower your mortgage interest by 1% or more.
- Shorten your loan term: To pay off your loan faster, refinance and get a shorter mortgage term. Bundle your shorter loan term with a lower interest rate and you’ll get more value out of the process.
- Switch from an adjustable-rate to a fixed-rate mortgage: If your adjustable-rate mortgage (ARM) is near the end of its introductory period, you may be facing a steep interest rate hike. Refinancing to a fixed-rate mortgage can help you lock in a lower rate for the long term.
- Get rid of mortgage insurance: If you didn’t put 20% down when you first bought your home, you’ve probably been paying mortgage insurance. With a refinance, you may be able to get rid of it sooner and save money.
- Take cash out: If you have more than 20% home equity, you can use a cash-out refinance to borrow against it. You can use this money to consolidate and pay off your debts at a lower interest rate.
While the benefits sound great – and they are – you need to balance them against any risks or costs:
- A credit score drop: Any time you apply for a loan, it gets recorded against your credit score. While the number will eventually go up again, you may want to be careful if there’s a risk of your credit score dropping below 600. This isn’t the end of the world, but it can make it harder for you to borrow in the future.
- Closing costs: When you refinance, you’ll need to pay closing costs, which can equal up to 6% of the value of the loan. If cash is tight, you may be able to take advantage of a no-closing-cost refinance. The option lets you pay less money upfront, but you’ll deal with larger monthly payments and higher interest in the long run.
- A low home appraisal: When you refinance, your lender may request a home appraisal (an independent report on your home’s value). If the appraisal is lower than you anticipated, you may find yourself with less equity and less favorable terms to consider.
Now that you know the benefits and challenges, let’s look at some ways you can up your chance of getting a better mortgage refi – even with less-than-perfect credit.
Boost Your Credit Score: Check Your Digits
Before you look at lenders, get a copy of your credit history from one of the big three credit bureaus: Equifax®, Experian™ or TransUnion®.
Take a look at your credit score and see how close it is to your lender’s minimum qualifying credit score.
Cleaning up your credit can take time, especially if you have a history of late payments or other issues, but there are ways to quickly give your credit a small boost and improve your chances of qualifying for a better loan:
- Ask your credit card companies to increase your credit limit.
- Pay debts off quickly by getting a family loan or cashing out mature bonds.
- Charge a small amount to an unused credit card.
- Open a new card and don’t use it. (This isn’t the best choice for those looking for a quick credit score boost, or for those looking to refi in the short term.)
- Check your credit report and see if there are any errors you need fixed.
- Review your student loans and see if there are any consolidation or refinancing options out there to lower your monthly payment.
A payment that’s over 30 days late can lower your credit score by as much as 100 points. If it was a one-off, ask your lender for a “goodwill adjustment.”
Talk To Your Current Lender: The Personal Touch
If your current mortgage is in good standing with your lender, talk to them first.
Lenders, especially banks, credit unions and larger lenders, like to tout their customer service, and they don’t want to lose your business.
If you had a loan officer that you worked with before, reach out to them or talk to a real person at a branch.
Work With a Mortgage Broker: Get Expert Advice
A mortgage broker can help shop your mortgage application to a wider range of lenders. They may also be able to present you with loan programs or ideas that may not be common knowledge.
Find a Non-Occupying Co-Client: Leverage Your Connections
Like a co-signer, a non-occupying co-client is someone with good credit who agrees to take responsibility for your mortgage loan if you default. But unlike a spouse or family member who may co-sign for you, a non-occupying co-client can’t live in the home.
When lenders consider your application, they will take your credit score and finances into account as well as the co-client’s. While a co-client can help make your application look better, lenders will judge your application based on the lowest of the two credit scores.
Depending on the loan type, your co-client may need to be on the title of your home. So prioritize on-time payments, or you may jeopardize your relationship with your co-client.
Ask About Portfolio Loans: The Private Label Option
Lenders don’t usually advertise these, but they may be able to offer you a portfolio loan if your credit score doesn’t meet the usual minimum of 620. This loan is essentially an exclusive deal between you and the lender.
The upside is that they may be more willing to be flexible about your credit score. The downside? The lender may charge higher interest rates and the terms may be less favorable overall.
Use an FHA Refinance Option: Get Uncle Sam To Assist
The Federal Housing Administration (FHA) has helped millions of Americans who may not have been considered eligible get mortgages.
Even if you haven’t used an FHA mortgage before, the FHA can help you refinance your mortgage.
FHA lenders offer several mortgage refinancing programs for people with lower credit scores:
FHA streamline refinance
If you already have an FHA loan and want to refinance, an FHA Streamline Refinance can help you do it in less time. It requires less paperwork, and you may be able to skip the home appraisal. To qualify, you’ll have to show that you’ve made 12 consecutive, on-time monthly mortgage payments.
FHA rate-and-term refinance
If you have a conventional mortgage but you’re having a hard time getting a refinance through a conventional lender, the FHA can help.
A rate-and-term refinance lets you convert a conventional loan to an FHA loan, but it comes with a more involved process that includes income and credit checks and a home appraisal. Like the FHA Streamline, you’ll have to show that you’ve made 12 consecutive, on-time monthly mortgage payments to qualify.
FHA cash-out refinance
If you want to use your mortgage refinance to borrow cash against your home equity, the FHA can help here, too. To qualify, you’ll need to have at least 20% equity in your home and show that you’ve made 12 consecutive, on-time monthly mortgage payments.
Use a VA IRRRL
Like the FHA Streamline, this refinance option is designed to be quick and easy.
To qualify, you’ll need to demonstrate 6 consecutive months of on-time payments and show that it’s been at least 6 months since you made your first payment on your current VA loan.
Refinance When It’s Right For You
Whether you choose to refinance or not will be up to you. Even if it seems like everyone around you is refinancing, remember that refinancing is an investment in time – and money.
It should be a tool that improves your situation, not an option you take because someone tells you it’s a good idea.
Even if interest rates are low, if your credit score is standing in the way of a refinance that works in your favor, there’s nothing wrong with waiting until your credit score improves, so you can get the best rate.