How to Refinance Your Mortgage with Bad Credit


Refinancing your mortgage can provide you with a lot of financial benefits. You can cash out on some of your home’s equity when you need a large sum of money.

signing refinance papers

You can also take advantage of lower interest rates to save on your monthly payments. It’s also possible to get rid of your private mortgage insurance if you have enough equity in your home.

If your credit has taken a dive since you first bought your house, it may be difficult to refinance. After all, you’ll essentially be taking out a new home loan and will have to go through the entire application process with a mortgage lender.

However, you’re not left without any options. Learn how to make sure refinancing is the right move for you and how you can refinance your mortgage with bad credit.

Make Sure Refinancing Makes Financial Sense

Before applying to refinance your house, analyze the total cost of the transaction to ensure it’s the right move.

Yes, you might save money on your monthly mortgage payments with a lower interest rate, but remember that you also have to pay closing costs and other fees to get a new loan.

Refinancing Usually Extends Your Loan Term

Also, consider that your newly refinanced loan usually extends the length of your loan back to 30 years, regardless of how long you have been paying down your current loan. That means it will take longer to pay off your house and you’ll also be paying that interest for longer.

If you’ve been paying on your home for 10 years, that’s a long time to add back onto your mortgage, especially while making additional interest payments. Before you refinance, make sure you consider all of the financial implications, not just your new monthly mortgage payment.

Your lender can help you estimate what expenses you’re likely to incur so have an in-depth conversation before making a decision.

Refinance a Mortgage with Bad Credit

Credit scores and interest rates go hand in hand. As with all loans, a higher credit score results in lower interest rates, saving you money every month. This really adds up on mortgages because you’re paying the loan off for so long. And even if you don’t have excellent credit, you still might be able to get approved for a home loan.

Shop Around

Start off by shopping around for lenders. You’re under no obligation to use the same lender as your initial mortgage, and it’s good to compare several offers.

Refinanced home loans can be structured in any number of ways and some may work for you better than others. For example, you might want to roll closing costs into the loan rather than paying them in cash up front.

Mortgage Points

If you plan on staying in your home for a long time, it may be worth paying an extra point at closing in order to get a better interest rate. Think about what your goals are in refinancing and talk to each lender about the different ways you can achieve them.

A good lender can also help you prepare to get approved for a mortgage refinance, even with lower credit scores. If you can, demonstrate that you have strong cash reserves by putting extra money in the bank.

You’re more likely to be approved for a loan if you have money on hand that is accessible because it shows that you’ll be able to pay for your loan even if your monthly budget is tight at times.

Pay Off Debt

Another helpful move is to strategically pay down some of your debt. Although each lender’s exact requirements vary, most like to see a debt to income ratio of less than 41%.

That means the number of recurring debt payments you make each month (like your new mortgage, your credit card minimums, and any personal loans), should only take up 41% of your monthly pre-tax income.

For example, let’s say your monthly income amounts to $5,000 before taxes and health insurance are taken out, and you pay $2,000 a month on credit cards and a car loan.

Divide 2,000 by 5,000 and you’ll get 0.4. Multiply that by 100 to find the percentage of your debt to income. In this case, it’s 40%, which is less than most lender’s required minimum.

To strengthen your application, consider making a few extra payments to lower your debt amount even more. It may take a few months for those numbers to be reflected on your credit report, so ask your lender to perform a rapid rescore if you’re in a hurry.

Getting a Co-signer

If a bad credit score is still holding you back from refinancing a mortgage, you also have the option of adding a co-signer to the loan.

This basically means that someone else with better credit can help get you approved without having to be an owner of the property title. They’ll be responsible for the loan until they’re removed, which can only be done through another refinance or selling the home.

The catch with having a co-signer is that they are also financially responsible for paying the mortgage. So if for some reason you can’t make the payments, your co-signer’s credit will also suffer — even if the loan gets all the way to foreclosure.

You definitely want a strong and trusting relationship with a co-signer and talk about what would happen in a worst-case scenario. Would the co-signer help make payments or be ok with having their credit diminished? Have an honest conversation to make sure you’re both comfortable with every possible scenario.

Required Documents

Once you’re ready to apply, you’ll need to supply the lender with similar documentation as you did when you first applied for a mortgage. This could include pay stubs, tax returns, and bank statements so they can determine your ability to repay the loan.

Another important part of the process if the home appraisal where a professional appraiser comes to your house and assesses its current value.

You’ll need to have at least 20% of the home’s value paid off, whether through mortgage payments or equity earned. So if your outstanding loan is $150,000 and the appraised value of the home is $200,000, you have 25% equity in your home and the appraisal should be good to go.

Federal Refinancing Programs

If you can’t get approved to refinance through a traditional lender, check to see if you qualify for one of these government-sponsored programs.

These options for refinancing a mortgage are specifically aimed to help people with bad credit. Each mortgage refinance option has different requirements, so read carefully before proceeding. If you qualify, you might be able to take advantage of significant savings.

Harp 2

This program is specially designed to benefit homeowners whose mortgage is greater than the value of the home, so there are no restrictions on the loan-to-value. However, you do have to meet some basic qualifications to take advantage of this program.

First, your loan has to be owned by Fannie Mae or Freddie Mac and must have been delivered to one of those entities by June 1, 2009. FHA loans don’t qualify and you can’t have already refinanced using Making Home Affordable Refinance Program (Harp 2’s predecessor).

FHA Rate and Term Refinance

If you already have an FHA mortgage, you may be able to qualify for an FHA Rate and Term Refinance. This option allows you to change the terms of your current FHA mortgage and replace them with more favorable terms. The minimum credit score to qualify is 580.

FHA Streamline Refinance Loans

If your current mortgage is not an FHA loan, you may be able to refinance your mortgage with an FHA Streamline Refinance. The minimum credit score is also 580. An FHA streamline refinance can help lower your interest rate, and you sometimes can get approved without having an appraisal performed, so it’s a speedy process.

FHA Cash-Out Refinance Loans

You can also do an FHA cash-out refinance have a minimum credit score of at least 620. The cash-out refinance allows homeowners with equity in their house to receive a lump sum of cash by increasing the principal mortgage amount (and, consequently, monthly payments).

VA Interest Rate Reduction Refinance Loan (VA IRRRL)

If you have an existing home loan backed by the U.S. Department of Veterans Affairs and you want to reduce your monthly mortgage payments, an interest rate reduction refinance loan (IRRRL) may be a good option for you. You can also move from a loan with an adjustable or variable interest rate.

Basically, a VA Interest Rate Reduction Loan lets you replace your current loan with a new one under different terms.

Improve Your Credit Score Before Refinancing

Whether your application to refinance was denied or you want to qualify for even lower interest rates, sometimes it’s worth taking the time to raise your credit score. Start by paying all of your monthly bills on time and in full. If you do that for long enough, you’ll start to see your credit score go up steadily.

You can also increase your credit card limit — as long as you don’t spend extra, you can quickly bump up your credit score.

Hire a Credit Repair Company

For people with a lot of negative items on their credit reports, a credit repair agency may be helpful in disputing those items and getting them removed altogether. Check out our reviews of the leading credit repair companies.

Credit scores are often categorized into five different ranges, from bad to excellent. If you can increase your credit score enough to boost yourself into the next category, you could automatically qualify for better refinance rates.

Don’t give up on your goal of refinancing your mortgage. There’s always room for improvement which means there’s always a way to get a better rate — even if it takes a bit of time.

Lauren Ward
Meet the author

Lauren is a Crediful writer whose aim is to give readers the financial tools they need to reach their own goals in life. She has written on personal finance issues for over six years and holds a Bachelor's degree in Japanese from Georgetown University.