How to refinance your home with bad credit

When to consider refinancing your mortgage

Several reasons may make it worthwhile to refinance your mortgage. Refinancing can be a hassle, but can also benefit homeowners by providing an influx of cash or freeing up funds on a monthly basis.

To change loan terms

A rate-and-term refinance can include switching from a shorter loan term to a longer loan term, for example, moving from a 15-year mortgage to a 30-year mortgage. This stretches out your payments, putting you in debt longer but with more-manageable payments.

It’s also possible to refinance to a shorter loan term, although if your credit isn’t fantastic it’s unlikely you’re ready to increase your monthly payments.

To reduce your interest rate or monthly payment

You can lower your monthly payment and the total you’ll pay over the life of the mortgage by refinancing to a lower interest rate. Always factor in closing costs on the refinance to determine whether you’ll save money overall.

David Behymer, a loan originator at UMortgage in northern Kentucky, said, “Ideally, if you are receiving a lower interest rate, you will be receiving a lower monthly payment. When it comes to rate-and-term refinances, lenders must ensure there is a net benefit to do so.”

To take cash out

Another option is a cash-out refinance, though a poor credit score can make it tough to get approval. Behymer said, “A cash-out refinance is a way to tap into the equity in your home in the form of a lump sum payment back to you.” He also explained that most lenders don’t restrict how you may use the cash, so things like education, home renovations or personal expenses are common uses.

According to Behymer, “Most loan programs allow for you to take out a loan for the cash-out refinance up to 80% LTV (loan-to-value).” Here’s a basic calculation for a cash-out refinance:

• $300,000 home value; you still owe $150,000
• $300,000 x 0.8 = $240,000
• $240,00 - $150,000 (the current lien on the property) = $90,000

This means you could theoretically pull out $90,000 minus closing costs through this refinance. Behymer added that VA loans may allow up to 100% LTV for a higher maximum cash-out option.

To remove mortgage insurance

For borrowers who put down less than 20% on their homes, paying PMI each month has a significant impact on overall budget. Behymer noted, “I’ve seen PMI cost people hundreds of dollars on their monthly payment.”

Still, you may not need to refinance to remove PMI, said Behymer. Instead, you can contact your mortgage servicer once you’ve reached 20% equity. Plus, as long as your payments are current, your lender is required to automatically remove PMI once your loan reaches 78% of the original principal, so you could also wait until that happens.

» MORE: Cash-out refinance vs. home equity loan (2024)

Ways to refinance with poor credit

Some options for refinancing your mortgage are more accessible than others if you have poor credit. Think through your reasons for wanting to refinance and whether any of these options could fit your situation.

Explore government-backed refinancing options

Government-backed programs for refinancing your home may help you if your credit isn’t great. However, other qualifications may be stricter (for example, you can’t access a VA loan if you are not in the military or a veteran). Alternative options include:

• FHA streamline refinance: This is for current FHA loans. If you already have an FHA loan, you might refinance with this option to get a lower rate or switch the type of mortgage (adjustable to fixed-rate, for example). Brian Shahwan, a mortgage banker and broker at William Raveis Mortgage, explained, “Those with less-than-stellar credit may find relief by going the FHA route as FHA loans typically have lower credit score requirements compared to conventional loans.”
• VA interest rate reduction refinance loan (IRRRL): This is also a “streamline” refinance that helps borrowers who currently have a VA loan get a lower interest rate or shift to a fixed-rate mortgage.
• VA cash-out refinance: If eligible as a member of the military or a veteran (or family member), you might try a VA-backed cash-out refinance. This can either be to access cash from home equity or to refinance a non-VA loan into a VA loan.
• USDA streamlined assist refinance program: This is limited to those with a USDA loan who have been current on the loan for at least 12 months. Shahwan noted, “USDA loans, while not directly related to credit score, generally have more lenient credit requirements, but are targeted to low-to-moderate income borrowers in rural areas.”

Consider a co-signer

One option you may pursue is adding a co-signer whose credit is significantly better than yours. Behymer explains that co-signers mainly assist with income qualifications and strengthen your overall file. He cautions that if you have a 600 FICO score and have a co-signer with an 800 FICO score, you don’t necessarily gain the benefits of an 800 score.

Shahwan also notes that a co-signer isn’t necessarily going to help by adding a higher credit score to the mix. He added, “On the other hand, if the co-signer has low debt and substantial income, this could absolutely assist in qualifying the borrower by getting them into an allowable debt-to-income (DTI) ratio.”

Shop around for lenders

A general tip for refinancing your home with poor credit is to do your homework. Shop around and obtain quotes from a variety of lenders. Try to stick to prequalification, which only uses a soft credit pull, rather than preapproval.

A general tip for refinancing your home with poor credit is to do your homework. Shop around and obtain quotes from a variety of lenders. Try to stick to prequalification, which only uses a soft credit pull, rather than preapproval. These are only quotes, but this way the process won’t harm your credit.

Traditional banks, online lenders and mortgage brokers may all have specific requirements to qualify for a mortgage refinance based on your credit score and other underwriting factors. Plus, each quote you obtain is something you can show to other potential lenders, which may lead them to make you a better offer.

Is it worth refinancing with poor credit?

When considering refinancing your mortgage, factor in how your credit score will impact the new home loan. Shahwan stated, “As mortgages are not a one-size-fits-all, it really depends on their specific situation to justify whether now is a good time or not.” In other words, find out whether you can qualify for a lower interest rate or cash-out refinance with your current credit score.

You need to first determine what kind of refinanced loan you can obtain with a less-than-perfect credit score, then calculate your potential savings. Work with a lender to compare your current mortgage payment to a refinanced payment, and be sure to take closing costs into consideration as well.

How to improve your credit for a refinance

You may discover that your credit simply isn’t high enough to warrant refinancing just yet. You may decide to work on raising your credit score for six to 12 months before pursuing a refinance. These strategies can help boost your credit:

• Pay all bills on time and in full. Payment history makes up 35% of your FICO score.
• Avoid opening new loans or forms of credit for the time being.
• Lower your credit utilization (the amount of available credit you’re using). This is part of “amounts owed” in your FICO calculation, which makes up 30% of your FICO score.
• Monitor your credit report and correct any errors.

Bottom line

Refinancing your home can offer lower monthly payments and savings over the life of the loan, but a bad credit score can make it challenging to qualify. You may look into government-backed options through FHA, VA or USDA loans if you’re eligible. Adding a co-signer to your loan may be an option as well.

Although credit scores aren’t the sole factor in whether you’re approved for refinancing, you’ll be more likely to get favorable terms if you can improve your credit first. Reducing your debts and making on-time payments can go a long way toward boosting your credit score, helping you qualify to refinance your mortgage.