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Refinancing a mortgage with bad credit: When it’s worth it (and when it’s not)

Aly J. Yale
The Mortgage Reports contributor

With less-than-perfect credit, can you still benefit from today’s low mortgage rates?

Low mortgage rates have many homeowners considering a refinance. And for those with great credit, it’s likely an easy decision to do so.

But for homeowners with less-than-stellar credit? The situation tends to be a bit more complicated.

The truth is, choosing to refinance with bad credit can put you at a disadvantage. In most cases, your credit score is a prime factor in both the rate and terms you’ll receive as a borrower, so having a low score could impact your options.

Still, a low credit score doesn’t bar you from refinancing entirely. In fact, there some situations where you might be able to benefit from a refinance. 

Why refinance a mortgage with bad credit?

The majority of homeowners refinance their mortgages to lower their interest rate and save on monthly and long-term interest costs.

If your credit score isn’t great, this might not be an option, as you won’t qualify for the lowest rates.

With that said, there are other reasons you might want to refinance. These include:

  • Speeding up your loan repayment (say, from 20-some years to 15 years)
  • Changing from an adjustable-rate loan to a fixed-rate loan
  • Leveraging your home equity to cover repairs or other expenses

Depending on your score and the rate on your current loan, there may still be a chance you could lower your rate and monthly payment with a refinance. Just make sure you shop around first.

Refinancing credit score requirements

If you’re set on refinancing, it’s important to know what loan products to focus on given your credit score. Each loan program (and unique lender) has its own credit score and debt-to-income requirements. 

Here’s how those break down:

  • FHA loans: FHA loans allow for credit scores as low as 500 (although many lenders post higher minimums; 620 or 640 is common) and DTI ratios up to 43% (50% in some cases*)
  • USDA loans: You’ll typically need a credit score of 640 for a USDA loan, though some lenders might go lower. The DTI cap on a USDA loan is 41% (46% in some cases*)
  • VA loans: VA loans don’t have a minimum credit score, though individual VA lenders typically require 620. VA requires a 41% DTI or less
  • Conventional loans: Conventional loans require at least a 620 credit score, though some lenders may ask for higher scores. The DTI cap is usually 45%

*Debt-to-income (DTI) requirements can vary by program and by lender

If you’re considering a cash-out refinance with bad credit, the score and DTI requirements will depend on which loan program you choose to go with.

Typically credit score minimums are much higher for cash-out loans.

You can select a cash-out refinance with FHA, VA, and conventional loans. USDA loans do not have a cash-out option.

Struggling with credit? You still have a few refinance options to choose from

If you’re refinancing with bad credit, there are several routes you can take.

For those with an existing FHA loan, the best bet is an FHA Streamline Refinance. This program requires a minimal look at your finances, and you can refinance with scores as low as 580 (sometimes 500, depending on the lender). You can also roll the down payment and closing costs into your loan, saving even more in up-front expenses.

If you have a VA loan, you can try an IRRRL, or Interest Rate Reduction Refinance Loan. Like the FHA Streamline, this one doesn’t require a lot of documentation, and there are no minimum credit scores. There’s also no home appraisal required, and you can roll the closing costs into your new loan.

Here are some other options for lower-credit borrowers to consider:

  • Refinance with your current lender: If you have bad credit, your best bet may be to talk to your current mortgage lender. As long as you’ve consistently paid on time, you have a qualifying DTI, and your employment is stable, they might be willing to work with you
  • Consider refinancing into an FHA or VA loan: If you have a conventional loan, refinancing into an FHA or VA loan might be an option. Both loan programs have low (or no) credit score requirements
  • Have a good amount of savings: Building up your savings account can also help your case. Having a significant amount in savings shows lenders you have a financial safety net that will prevent any late payments 
  • Consider an alternative loan program: There are alternative loan programs out there that may disregard credit scores entirely. One such example is SoFi’s “FICO-free” program

It’s worth it to shop around, too. Just as with your original loan, shopping around can ensure you get the best possible deal on your refinance. We recommend comparing rates and fees from at least three lenders (though more can never hurt!)

Some caveats about refinancing with bad credit

Keep in mind that although there are options to refinance with bad credit, it’s not always in your best interest to do so.

Because of the increased risk that lower-credit borrowers pose to lenders, it usually means higher fees and rates. These charges cut into any potential savings you would enjoy from the refinance.

If you’re refinancing for other reasons (to pay off your loan faster, to cash out on equity, or to avoid a rate hike on your ARM), then a refinance may be a wise choice.

You should also note that refinancing comes with fees. Make sure you have the cash to cover the closing costs you’ll incur, and know your long-term plans as a homeowner.

For a refinance to be worth it financially, you generally want to be in the home long enough to reach the “break-even point” — or the point at which your savings outweigh the costs of refinancing the loan. 

Tips to improve your credit score

To give yourself the best shot at refinancing successfully, boost your score before applying. These strategies can make a meaningful difference in your score:

  • Pay down some of your debts
  • Lower your credit utilization by cutting back credit card spending
  • Settle any collections or overdue accounts
  • Check your credit report for errors, using a service like annualcreditreport.com
  • Consider becoming an authorized user on a high-credit family member’s account. This can give your score a boost just by association

Want to gauge what refinance could do for you? Check out our refinance calculator.

Ready to start shopping for rates? Get your refinance quotes now.