Sometimes our situations change, and your old mortgage may no longer be working for you. In cases like this, it might be time to refinance.
A rate-and-term refinance allows you to switch up your interest rate and/or your loan term length, which can help you save money and free up cash flow. A cash-out refinance allows you to tap into your home equity to borrow money, possibly earning better terms on your mortgage too. During low-interest-rate environments, it may be even easier to achieve these two goals.
Most lenders require a good FICO score to refinance your loan, making it difficult for many homeowners to refinance their mortgage with bad credit. There are ways you can work around this barrier, however — we’ll cover your options in this article.
Understanding bad credit refinance
Lenders want to make sure you’ll be able to pay them back, and your credit score is a powerful predictor of this. Most lenders have certain credit score thresholds, and if yours falls below this, they may not approve you for a refinance. Typically, most lenders require a credit score of 620 or higher for a conventional rate-and-term refinance. With a cash-out refinance, bad credit can be an even greater barrier due to the larger loan amount.
If lenders do approve you for a bad credit refinance, they may charge additional fees and higher interest rates that can negate any benefits you’ll get from the loan. If you’re refinancing in order to lower your monthly payment, for example, the rates that lenders might be offering can make your new mortgage even more expensive than the one you already have in some cases.
However, people refinance their mortgage for many different reasons. It helps to know the pros and cons of refinancing so you can understand whether it’s still a good decision in your scenario.
Advantages of a bad credit refinance
- Opportunity to build credit: Having your lender report your loan activity to the credit bureaus (as opposed to a payment-free option) can help you build credit by demonstrating a positive credit history of on-time payments.
- Affordable loan payments: If you refinance for a longer term length or for a lower rate, your monthly payment may be reduced, so you won’t have to pay as much each month. This may be difficult with a bad credit refinance, however, since you may have to pay a higher rate relative to the prime rate.
- Possible to eliminate mortgage insurance: Some FHA loans require you to make pricey mortgage insurance payments for the life of your loan, unlike most mortgages that allow you to cancel this payment once you’ve reached 20% equity. Refinancing into a different home loan option allows you to remove that extra FHA mortgage insurance payment.
Disadvantages of a bad credit refinance
- Very expensive: Refinancing is expensive in general, and that’s especially true if you’re refinancing a mortgage with bad credit. You may be charged additional fees and a higher rate, which can increase your monthly payment amount.
- Difficult to get approved: It may be difficult to get approved for a refinance loan at all if you have bad credit. The lower your credit score, the harder it will be to get a new mortgage with bad credit.
- Increases your loan term: You can refinance for a shorter term length, but most people choose longer loan terms in order to benefit from lower monthly payments. That does mean you’ll be in debt for longer, however. Check the amortization schedule for the two loans to see how they compare and contrast.
- Danger of defaulting on loan: You already know that you can lose your home to foreclosure if you default on your mortgage, and that’s also true if you refinance your loan. The danger of this only increases if you refinance for a longer term length or a higher monthly payment amount.
- Better options may be available: Many people think that a bad credit refinance loan is their only option, but that’s far from the truth. There are many good alternatives out there that you can explore first.
3 ways to refinance with bad credit
If you’ve crunched the numbers, considered your alternatives, and still decided that refinancing your mortgage is your best option even with your credit score, here are some avenues to explore:
Apply with a co-signer
If you have someone you love and trust with better credit than you, one option is to ask them to be a co-signer on your loan. This may be enough of an incentive for a lender to approve your loan application because if you default on the loan, they can pursue your co-signer for repayment. Of course, this means you’ll need to ensure you do make those payments so that you don’t burn a bridge with someone important in your life.
Work with your mortgage lender
A good strategy is to swing back to the lender who gave you your current mortgage in the first place. In some cases, they may be more willing to work with you than other lenders because they may be hungry for repeat business.
See if you’re eligible for a government-backed loan refinance
Most conventional lenders require a credit score of 620 or higher for a refinance, but in some cases, certain government-backed mortgage refinance programs don’t have any credit score requirements at all. These may only apply to certain groups of people, but it’s still worth browsing down the list to see if you may be eligible for any of these refinance programs:
- FHA streamline refinance: If you’ve made your last six payments on time and meet other criteria, you may be eligible to refinance your FHA loan to a lower rate without undergoing any credit check at all.
- FHA cash-out refinance: If you want to borrow against your home equity using your existing FHA loan, you may be able to get approved with a credit score as low as 580 with certain lenders.
- VA interest rate reduction refinance loan (IRRRL): If you’re an eligible veteran or service member, you may be able to get approved for this streamlined refinance with no credit check.
- USDA streamline refinance: The USDA doesn’t set any credit score requirements to refinance your already-existing USDA loan, although individual lenders are free to set their own credit requirements.
Refinancing your mortgage isn’t your only option for borrowing money. Here are a few other bad credit refinance mortgage alternatives to consider:
Build your credit
It often takes a long time to build excellent credit, but there are lots of smaller things you can do right now that will help improve your credit score quite quickly. If you don’t need to refinance right away, give these credit-building options a try first, and then recheck your credit score in a few months to see if it’s improved much.
Home equity loan
If you don’t want to replace your entire mortgage, another option to borrow funds is a home equity loan. It may still be challenging to find a lender that accepts bad credit, but this can be a good option to finance a large purchase, especially if you’re already paying lower rates on your current mortgage than on any potential bad credit refinance loans.
Home Equity Investment (HEI)
If you’re looking to borrow money and you don’t want to add to your monthly debt payments, a Home Equity Investment (HEI) may be a good solution. Your credit score may still be considered, but HEI providers like Point may be more willing to work with you than traditional lenders if you have bad credit. You can qualify for an HEI from Point with a credit score as low as 500 if you meet other requirements.
If you’re at least 62 years old, you may be able to take out a reverse mortgage if you need to borrow money. You’ll be required to pay off the remainder of your first mortgage with your loan proceeds. Reverse mortgages allow you to live in your home indefinitely without having to make any payments as long as you meet ongoing requirements.
Applying to refinance your home with bad credit can be a tough decision. If you’ve calculated your loan costs and you’re confident that you can afford them, taking out a bad credit refinance can be a viable option to borrow money or get better repayment terms. Most experts also recommend refinancing only if you plan on staying in your home for a while so you can recoup enough equity to cover any closing costs.
If you’re not sure whether a bad credit refinance is in your best interest or if you want a second opinion, try reaching out to a fee-only certified financial advisor who can guide you to the right approach. If you can’t afford a financial advisor, seek out a credit counselor from a reputable non-profit counseling organization who can help.