Through December 31, 2023, Experian, TransUnion and Equifax will offer all U.S. consumers free weekly credit reports through AnnualCreditReport.com to help you protect your financial health during the sudden and unprecedented hardship caused by COVID-19.
In this article:
- 1. Apply Through Your Current Lender
- 2. FHA Refinance
- 3. VA Interest Rate Reduction Refinance Loan (IRRRL)
- 4. USDA Streamline Refinance
- 5. Find a Co-Borrower
- What Is a Bad Credit Score for Refinancing?
- Pros and Cons of Refinancing With Bad Credit
- How to Improve Your Credit Score for a Mortgage Refinance
- The Bottom Line
It's common for mortgage lenders to require a credit score of 620 or above to get approved for a refinance loan. As a result, if you have bad credit (your credit score falls in the FICO® Score☉ range of 300 to 579), your options may be limited.
But limited options can still be better than nothing. Here are some to consider and what it takes to get approved for a mortgage refinance loan despite bad credit.
1. Apply Through Your Current Lender
If you let your mortgage lender know you're interested in a refinance before you start looking elsewhere, it might be more likely to work with you to keep your business. What's more, it may be more willing to take certain factors into account beyond your credit score.
That said, it's also smart to shop around and compare rates from other sources—then let your lender know you're exploring or have received other offers.
2. FHA Refinance
The Federal Housing Administration (FHA) provides multiple mortgage refinancing programs for those with lower credit scores. They include:
- FHA streamline refinance: As its name implies, this process allows you to refinance an existing FHA loan with less paperwork and potentially lower credit standards than a typical refinance, as long as you've made 12 on-time mortgage payments. It will typically result in a lower mortgage payment.
- FHA rate-and-term refinance: If you have a conventional loan, you can apply for an FHA rate-and-term refinance, which may allow a minimum credit score as low as 500. You also must be able to demonstrate 12 months of on-time mortgage payments.
- FHA cash-out refinance: This option allows you to get a new home loan larger than your previous loan, plus cash for the difference. To qualify, you'll need at least 20% equity in your home and a history of on-time payments for 12 months—or for the length of the loan term so far if it's shorter than that. The minimum credit score is generally 580, though, so you may need to improve your score before applying.
3. VA Interest Rate Reduction Refinance Loan (IRRRL)
If you currently have a home loan insured by the U.S. Department of Veterans Affairs, known as a VA loan, you may be able to refinance it without undergoing a credit underwriting process or a home appraisal with the VA IRRRL program.
You could also avoid paying out-of-pocket fees, since they can be rolled into the cost of the loan. The agency recommends comparing rates from multiple lenders before moving forward.
4. USDA Streamline Refinance
Current homeowners with mortgages insured by the U.S. Department of Agriculture can refinance their USDA loans even if they have no or low equity.
Similar to the VA IRRRL program, you're not required to undergo a credit review, but you must show 12 months of on-time payments. You must also meet income eligibility requirements.
5. Find a Co-Borrower
Whether they plan to live in the home or not, consider adding a co-borrower to your refinance application.
A co-borrower agrees to share the responsibility of paying back the loan, so if you find one with good credit, it could help you get approved and even improve your odds of securing a favorable interest rate.
What Is a Bad Credit Score for Refinancing?
On the FICO® Score scale, a bad credit score ranges from 300 to 579. The credit requirements for a mortgage refinance loan can vary by lender and type of mortgage.
In general, though, you'll need a credit score of 620 or higher for a conventional mortgage refinance. Certain government programs require a credit score as low as 500 in some cases or may have no minimum at all.
Even if you meet the minimum requirements for a loan, a higher credit score will not only improve your chances of approval but also help you secure a lower interest rate and other favorable terms.
Beyond credit score, it's also worth evaluating whether you have the funds to pay the closing costs and fees associated with refinancing, including any prepayment penalties your original lender may charge.
Lenders will also look at your debt-to-income ratio (DTI), or your total monthly debt payments compared with your income. It's ideal for your debt obligations to be no more than 43% of your monthly earnings, though some lenders will accept a higher amount.
Pros and Cons of Refinancing With Bad Credit
While it's best to work on improving your credit before you apply to refinance your home loan, there may be situations where it's better not to wait. Here are some of the benefits and drawbacks to consider.
- Potentially reduce your costs: If you have significant equity in the home or its value has increased significantly, refinancing could allow you to remove mortgage insurance payments. You may even be able to qualify for a lower interest rate, especially if market rates were high when you first took out the loan.
- Change your loan terms: Refinancing your home loan could result in a longer repayment term, which can lower your monthly payment. Keep in mind, though, that extending your loan term will typically result in higher long-term interest costs.
- Switch rates: If you have an adjustable-rate mortgage and you're nearing the end of your initial fixed period, it can be worth it to refinance to a fixed-rate mortgage. Even if your new rate will be higher, it'll ensure that it won't fluctuate.
- Potentially higher interest rate: While it's possible to get approved for a refinance loan with bad credit, you may end up with a higher interest rate than what you're currently paying.
- Closing costs: You'll need to make sure you can afford to pay the upfront closing costs on the loan, which can range from 2% to 5% of the loan amount. Some lenders may allow you to roll the closing costs into the loan, but financing these costs will ultimately make your loan more expensive.
- Could lower your credit score: Applying for a refinance loan typically results in a hard inquiry on your credit reports, which can ding your credit score a bit. Additionally, opening a new loan could also negatively impact your credit score in the short term.
How to Improve Your Credit Score for a Mortgage Refinance
Unless refinancing your home loan is an urgent matter, it's best to work on improving your credit before you start submitting applications. Here are some steps you can take.
1. Review Your Credit Score and Reports
Your credit score offers a quick snapshot of your overall credit health, and your credit reports will give you the underlying information you need to determine where to focus your efforts.
You can check your credit score for free with Experian and also get a free Experian credit report anytime. You can also access your credit reports from Equifax and TransUnion through AnnualCreditReport.com.
2. Take Action Based on Your Situation
There are some things anyone can do to improve credit, but if your score is in poor shape, you'll likely need to use your credit reports as your guide to determine your next steps. Potential steps you can take include the following:
- Catch up on past-due accounts.
- Pay off collection accounts.
- Pay down high credit card balances.
- Dispute inaccurate information found in your reports.
- Remove yourself as an authorized user from an account with a poor history.
If you have some major derogatory marks on your credit report that you can't dispute, such as late payments, a repossession or bankruptcy, it may take some time for your credit score to recover. While developing good credit habits can help, you may also need to practice patience.
3. Consider Other Steps
Beyond quick fixes, your credit score may benefit from adding more positive history to your credit reports. Some other steps to improve your credit include the following:
- Apply for a secured credit card or a credit-builder loan.
- Ask a loved one with good credit to add you as an authorized user on their credit card account.
- Maintain a low credit utilization rate—your balance relative to your credit limit—on your credit cards.
- Avoid applying for credit unless you absolutely need it.
4. Don't Forget About Non-Credit Factors
Beyond your credit score, there may be other factors you can improve to make a better impression when you're ready to apply for a refinance loan:
- Build your cash reserves to better weather financial storms.
- Pay off loans and credit card balances to reduce your DTI.
- Look for ways to increase your regular income.
- Consider another loan program if the one you're interested in won't approve you.
The Bottom Line
Bad credit doesn't have to stop you from pursuing a mortgage refinance, especially if you're able to take advantage of a government program through the FHA, USDA or VA.
But carefully consider your situation and options to determine whether you need to refinance now or if you can wait and improve your credit before you apply. You'll also want to consider closing costs and whether the new loan will be more or less expensive than your existing one.
As you go through the refinance process, continue to monitor your credit so you can better understand how to improve your score and address potential problems as they arise.