How to Refinance a Mortgage With Bad Credit

Refinancing a mortgage with bad credit may be possible, but approval is only part of the decision. A new loan could lower your rate or monthly payment, but it could also add closing costs, restart your repayment term or increase the total interest you pay.

Your options depend on your current mortgage, credit history, income, home equity and payment record. Government-backed streamline programs may offer a simpler path for some borrowers, while a fully underwritten refinance generally requires a more complete review of your finances.

Can you refinance a mortgage with bad credit?

Yes, you may be able to refinance with bad credit. However, there is no universal score that every refinance lender uses.

According to the Consumer Financial Protection Bureau, lenders consider your credit reports and scores along with factors such as your:

• Income and employment.
• Existing debts.
• Cash reserves and other assets.
• Home equity.
• Mortgage payment history.
• Requested loan type and term.

Borrowers with scores below 620 may have more difficulty obtaining a conventional mortgage, but program rules, automated underwriting results and lender requirements vary. Some government-backed refinance programs do not impose the same type of credit-score underwriting used for a standard conventional refinance.

Even if you qualify, compare the new loan’s total cost with your current mortgage. A higher rate, expensive mortgage insurance or a longer repayment term could outweigh the benefit of refinancing.

Decide what refinancing needs to accomplish

Before applying, identify your primary goal. You may want to:

• Lower your interest rate.
• Reduce your monthly payment.
• Change from an adjustable to a fixed rate.
• Shorten or extend your repayment term.
• Remove a borrower from the mortgage.
• Borrow against your home equity.

These goals can lead to different outcomes. Extending a loan from its remaining term into a new 30-year mortgage may lower the monthly payment but increase the total interest paid. A shorter term may reduce total interest but raise the payment.

A cash-out refinance replaces your mortgage with a larger loan and gives you part of the difference in cash. It also reduces your home equity and puts the borrowed amount behind a loan secured by your home. If you cannot repay the new mortgage, you could face foreclosure.

Read more >> Cash-Out Refinance vs. Home Equity Loan: What’s the Difference?

Refinance options for homeowners with bad credit

The most appropriate program may depend on the type of mortgage you already have.

Conventional refinance

Conventional refinance requirements vary by lender, loan purpose, property type and underwriting method. A 620 score is commonly associated with certain conventional mortgages, but it is not a universal minimum for every conventional refinance.

Lenders may also consider your loan-to-value ratio, or LTV. This percentage compares the mortgage balance with the home’s value. More equity generally means a lower LTV, which can make the loan less risky for the lender.

A conventional refinance may be worth exploring if you have:

• A consistent mortgage payment history.
• Stable, documentable income.
• Manageable monthly debt.
• Significant home equity.
• Cash reserves or funds for closing.

Ask several lenders to evaluate your complete profile instead of assuming that one score determines whether you qualify.

FHA streamline refinance

An FHA streamline refinance is available only when the existing mortgage is already FHA-insured. It cannot be used to refinance a conventional mortgage into an FHA loan.

The Department of Housing and Urban Development states that an FHA streamline refinance must generally:

• Refinance an existing FHA-insured mortgage.
• Replace a mortgage that is current.
• provide a net tangible benefit to the borrower.
• Limit cash received by the borrower to no more than $500.

FHA offers credit-qualifying and non-credit-qualifying streamline refinances. A non-credit-qualifying refinance requires less documentation and underwriting, but the lender may still impose its own requirements.

“Streamline” does not mean free. FHA generally does not allow ordinary closing costs to be added to the new streamline loan balance. A lender may cover them in exchange for a higher rate, or the borrower may pay them at closing.

FHA rate-and-term refinance

A fully underwritten FHA rate-and-term refinance may be used to replace certain conventional or FHA mortgages. Unlike a streamline refinance, it generally requires income, credit and property underwriting.

Under HUD’s FHA guidelines, borrowers with a minimum decision credit score from 500 to 579 are generally limited to a maximum 90% LTV. Borrowers with scores of 580 or higher may qualify for the maximum financing allowed by the applicable FHA refinance program.

These are FHA insurance standards, not a promise of approval. Lenders may set stricter credit requirements, and the property and borrower must satisfy the other FHA rules.

FHA loans also include mortgage insurance. Compare the insurance premiums and total monthly payment with the costs of your current mortgage and other offers.

VA Interest Rate Reduction Refinance Loan

A VA Interest Rate Reduction Refinance Loan, or IRRRL, is available to eligible borrowers refinancing an existing VA-backed mortgage.

According to the Department of Veterans Affairs, you must use the IRRRL to refinance an existing VA-backed loan and certify that you currently live in or previously lived in the home.

An IRRRL can be used to:

• Lower the interest rate and monthly mortgage payment.
• Replace an adjustable-rate mortgage with a fixed-rate loan.
• Change the mortgage term when program requirements are met.

A standard VA appraisal and full credit-underwriting package are not normally required, although additional review may apply in certain circumstances and individual lenders may set requirements.

IRRRLs have closing costs and may include a VA funding fee. You may be able to include allowable costs in the new loan or accept a higher rate in exchange for lender-paid costs. Either option can increase the amount you pay over time.

USDA Streamlined Assist refinance

A USDA Streamlined Assist refinance is available to qualifying borrowers with existing USDA Section 502 direct or guaranteed loans.

Under USDA regulations, this option generally:

• Requires the borrower to meet applicable household-income limits.
• Requires an acceptable recent mortgage payment history.
• Does not require a new credit report or DTI calculation.
• Does not usually require an appraisal, with a limited exception for some direct-loan borrowers.
• Requires a new fixed rate that does not exceed the rate on the existing loan.
• Must provide the required reduction in the borrower’s total monthly mortgage payment.

USDA rules and lender documentation requirements still apply. Contact a participating lender or USDA Rural Development to confirm eligibility.

Non-qualified mortgage refinance

A non-qualified mortgage, or non-QM loan, does not meet the federal standards required for a qualified mortgage. Some non-QM lenders use alternative documents, such as bank statements, to evaluate self-employed borrowers or people with income that is difficult to document through standard tax forms.

Non-QM does not mean that a lender can ignore your ability to repay. Avoid offers suggesting that you can obtain a mortgage based only on unverified “stated income.”

These loans may have higher rates, larger down-payment or equity requirements and additional fees. Compare the total cost carefully and verify that the lender is properly licensed. If you are considering a non-QM loan after bankruptcy, foreclosure or another financial setback, consider reviewing the offer with a HUD-certified housing counselor or qualified financial professional.

What to expect when refinancing with bad credit

Refinancing with a weaker credit profile may affect your rate, fees and documentation requirements.

A higher interest rate

Credit is one of several factors lenders use to price a mortgage. A lower score or recent negative credit history may result in a higher rate.

Do not refinance solely because a lender approves you. Compare the new rate with your existing rate and calculate whether the savings justify the closing costs.

Mortgage insurance or program fees

Depending on the loan, you may pay private mortgage insurance, FHA mortgage insurance, a VA funding fee or a USDA guarantee fee.

These costs do not work the same way. For example, private mortgage insurance pricing can depend partly on your credit and equity, while FHA mortgage insurance follows FHA program rules. Review the complete monthly payment rather than comparing only principal and interest.

More documentation

A lender may request:

• Recent pay stubs.
• W-2 forms or tax returns.
• Bank and investment statements.
• Employment verification.
• Current mortgage statements.
• Homeowners insurance information.
• Explanations and documents related to recent late payments, collections, bankruptcy or foreclosure.

Providing complete, consistent documents can help prevent delays. Alternative-documentation loans may require different records, but that does not mean verification is unnecessary.

Closing costs

A refinance may include:

• Origination and underwriting charges.
• Appraisal fees.
• Credit-report fees.
• Title services and title insurance.
• Recording fees.
• Discount points.
• Mortgage insurance or government program fees.
• Prepaid interest and escrow deposits.

A “no-closing-cost” refinance is not free. The lender typically recovers those costs through a higher interest rate or by adding allowable expenses to the loan balance.

Read more >> What Is a No-Cost Closing Refinance?

How to compare refinance offers

Request Loan Estimates from several lenders for the same loan amount, term and type. The standardized form makes it easier to compare offers.

The CFPB recommends comparing:

• Loan amount and term.
• Fixed or adjustable interest rate.
• APR.
• Monthly principal and interest.
• Mortgage insurance.
• Total estimated monthly payment.
• Origination charges.
• Discount points and lender credits.
• Cash needed to close.
• Five-year borrowing cost.

Mortgage rate-shopping inquiries completed within a focused period are generally treated as one inquiry by widely used scoring models. The CFPB recommends keeping mortgage inquiries within 45 days.

Calculate your break-even point

Your break-even point estimates how long it will take for the monthly savings to recover the upfront refinancing costs.

Use this calculation:

If you expect to sell or refinance again before 40 months, the loan may not produce enough savings to recover its costs.

This calculation is most useful when the new payment is genuinely lower. For a cash-out refinance or a refinance that changes the loan term, also compare the total debt and interest paid over the period you expect to keep the loan.

Review the Closing Disclosure

For most refinances, the lender must provide a Closing Disclosure at least three business days before closing. Compare it with your latest Loan Estimate.

Check the:

• Loan amount and interest rate.
• Monthly payment.
• Closing costs.
• Cash needed to close.
• Mortgage insurance.
• Escrow treatment.
• Prepayment penalty or balloon-payment terms, if any.

Ask the lender to explain unexpected changes before signing.

How to strengthen your credit profile before refinancing

If refinancing is not urgent, working on your credit and finances first may help you qualify for more competitive offers.

Review your credit reports

Request your free weekly reports from Equifax, Experian and TransUnion at AnnualCreditReport.com. Check account balances, payment history, collection accounts and personal information.

Dispute information that is inaccurate or incomplete. Accurate negative information generally cannot be removed merely because it is unfavorable.

Pay every bill on time

Payment history is an important credit-scoring factor. Bring any past-due accounts current when possible and make at least the required payment by each due date.

Autopay or payment reminders can help, but confirm that the account used for automatic payments has enough money to cover the charge.

Reduce revolving balances

Paying down credit card balances may lower your credit utilization, which compares your balances with your credit limits. Lower utilization can help your credit profile, but do not empty emergency savings if doing so would make it harder to cover your mortgage or other essential expenses.

Avoid unnecessary credit applications

A new credit application can create a hard inquiry, and opening an account may affect several parts of your credit profile. Avoid taking on unnecessary debt while preparing for a mortgage application.

Mortgage rate shopping is different: scoring models generally group qualifying mortgage inquiries made within a designated shopping period.

Keep financial documentation organized

Credit is only one part of underwriting. Stable income, manageable debt, sufficient equity and cash reserves may strengthen an application.

Gather recent statements and income documents before approaching lenders. If you are self-employed, ask what documentation each lender requires before applying.

Bottom line

Refinancing a mortgage with bad credit may be possible, particularly if you qualify for an FHA, VA or USDA streamline program. However, qualifying does not necessarily mean the new mortgage will save you money.

Compare several Loan Estimates, calculate your break-even point and examine the complete monthly and long-term costs. If you need help evaluating a refinance, the HUD housing-counselor directory can connect you with an approved counselor.

If you want to establish additional positive payment history before applying, Kikoff’s Credit Account reports on-time payments to all three credit bureaus, with no hard credit check to sign up. Mortgage approval, rates and terms depend on the lender and your overall financial profile.