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How to Refinance a Mortgage With Bad Credit

Learn how to refinance your mortgage if you've got bad credit, including options that have the highest chances of approval.

When mortgage interest rates decrease, refinancing is an excellent way to reduce your rate and monthly payment.

A lower monthly payment allows you to save more each month. You can then use the money to pay off debt, build an emergency fund, or make home improvements. 

Refinancing can also serve other purposes. You can switch from an adjustable-rate mortgage to a fixed-rate, remove someone’s name from the mortgage, and even cash out your equity.

But while refinancing—the process of getting a new mortgage to replace an existing one—is a common practice, it’s easier said than done when you have bad credit.

What Is Bad Credit?

Your credit score is a three-digit number that creditors and lenders used to gauge creditworthiness.

FICO credit scores -- used most often by U.S. lenders -- range from 300 to 850. The higher your personal score the easier it is to get approved for loans.

People with the highest scores have a successful track record of managing credit and debt.

This makes them ideal candidates for refinancing.

Typically, good credit is a score of 670 or higher. Scores between 580 and 669 are considered fair, putting a borrower in a subprime category. Bad credit is any score under 580.

Why Is It Harder to Refinance With Bad Credit?

Getting a loan or a credit card with bad credit isn’t impossible. Some banks have products specifically for people who have a low score.

The problem, though, is that these products tend to have higher rates. 

So if you’re interested in refinancing with the sole purpose of getting a better rate, the rate you receive might not be as low as expected. It might, however, be lower than what you’re currently paying. And if so, you’ll enjoy some monthly savings. 

But even if you’re okay with not qualifying for rock bottom rates, refinancing with bad credit is harder because it requires applying and getting approved for a new mortgage

An existing mortgage alone doesn’t qualify one for refinancing. Since it’s a new mortgage, you have to go through the qualifying process again. This includes submitting supporting documentation to the lender. In most cases, authorizing a credit check, too.

And unfortunately, if your credit score is lower than when you received the original loan, the lender may deny your application.

Although difficult to refinance with bad credit, it’s not completely off the table. The key is knowing how to approach the refi process, and choosing the right lender.

Improve Your Credit Score Before Refinancing

Adding even a few points to your credit score before refinancing can make a big difference. 

When reviewing your loan application, the lender will look at your recent credit history.

Despite mistakes you’ve made in the past, having no late payments within the previous 12 months can improve your odds of getting approved with a low credit score.

To improve your credit score, start by paying your bills on time every month. Set payment reminders and automate your bills. Remember, payment history makes up 35 percent of your credit score. 

Also, you should pay down debt. Getting rid of credit card debt especially can quickly give your credit score a boost. This can make it easier to refinance with bad credit. The amount you owe makes up roughly 30 percent of your credit score.

Take the time to examine your credit report, too. Credit reporting errors can unknowingly drive down your credit score. Get your report from AnnualCreditReport.com. From here, dispute any errors or mistakes so the bureaus can remove these from your credit file.

Refinance With Your Current Lender

Your chances of refinancing with bad credit might be higher if you use your current mortgage lender. This can work in your favor, especially if you’ve never missed a mortgage payment. 

Sometimes, refinancing results in a lower monthly payment. So if you haven’t had any trouble paying your mortgage at the current amount, you probably won’t have difficulty paying a lower amount.

Contact a loan officer with your current lender and schedule an appointment. You can discuss refinance programs and receive a free quote. 

Shop Around and Compare Other Lenders

But even if your current mortgage lender offers refinancing, their offer might not be the best available. For this reason, you should also shop around and compare other lender offers. 

As a general rule of thumb:

Get at least three or four refinance quotes.

In addition to your lender, request free quotes from a credit union or community bank. 

These financial institutions might keep some of the home loans they originate. So they might be more willing to approve people with bad credit. 

Some banks sell the majority of their mortgages on the secondary market. As a result, they have to adhere to strict underwriting standards, which might include denying applicants who have very low credit scores.

Get an FHA Streamline Refinance

An FHA mortgage is one of the easiest loans to get with bad credit. This not only applies when applying for an original mortgage, but also when refinancing with bad credit. 

If you have an existing FHA loan, you might qualify for an FHA streamline refinance. This is for people looking to lower their interest rate and monthly payment only. It’s an option if you have a low credit score because there’s no credit check or debt-to-income requirement. It also features no appraisal and low closing costs. 

To qualify, you must have made your monthly payment on time for the last 12 months.

Other mortgage programs also have streamline refinancing such as VA loans and USDA home loans. But these loans typically require a minimum credit score between 620 and 640.

Remove a Bad Credit Co-Borrower

Or maybe the problem isn’t your credit history, but rather the credit history of a co-borrower on the application. 

When you’re getting a mortgage with another person, their bad credit could affect your approval. This is because lenders sometimes use the lowest of the two credit scores to determine loan approval and the mortgage rate.

If you feel that your co-borrower’s low score might prevent refinancing or getting a competitive rate, consider applying for refinancing on your own. 

To do so, your credit score must be high enough to qualify alone, and your income must be enough to qualify for the mortgage.

Provide an Explanation for Bad Credit

Often times, bad credit isn’t the result of irresponsible behavior, but rather misfortune.

You might qualify for refinancing if you can show that bad credit is the result of a temporary hardship. 

What to Do Before Refinancing a House?

There are a few things you can do before applying for refinancing to help speed the process. 

Since you’re applying for a new mortgage loan, you’ll need to submit an application and possibly authorize a credit check. Be prepared to provide the following supporting documents:

  • Driver’s license
  • Tax returns for the previous two years
  • Recent paycheck stubs or W2s
  • Year-to-date Profit and Loss statement, if you’re self-employed
  • Bank statements for the previous 60 to 90 days

Before refinancing, you should also consider whether it makes sense at this time.

Ideally, you want the new interest rate to be lower than your present rate.

Understand, though, depending on your credit history, your new interest rate might not be much lower. However, you can still save money. 

Since you’ve had time to pay down your original mortgage, the amount you refinance will likely be less than the original mortgage balance.

You should also consider your goal of refinancing. Do you also want to shorten or extend the life of your loan? If you’re okay extending the life of the loan, you can reset the clock and refinance for another 30 years. This can further reduce mortgage payments. 

Or, you can choose a 15 or 20-year term and have a payoff schedule that’s similar to your original one.

If you have enough equity, there’s the option to borrow cash from your equity. This is great for home renovations and debt consolidation. Just know that borrowing cash from your equity increases your mortgage balance.

Don’t Forget to Think About Closing Costs

Another thing to consider before refinancing is how long you plan to live in the property. 

Refinancing a mortgage involves closing costs, which can be 2 percent to 5 percent of the mortgage amount. You can pay these fees out-of-pocket at closing, or wrap the cost into your mortgage balance. 

Ideally, you should live in the home long enough to recoup what you paid in closing costs. So if refinancing saves $250 a month, and you paid $4,000 in closing costs, you should live in the home for at least the next 16 months.

Final Word

Getting a loan with bad credit can be an uphill battle.

But the good news:

Refinancing with bad credit isn’t impossible as long as you choose the right program and the right lender.

Get a free quote from your current lender, and then compare their offer with those you receive from a credit union or community bank.