When you have a poor credit history or a low credit score, it can impact you financially, mentally, and emotionally.
Not only can a low credit score prevent you from being approved for further credit, but it can make it infinitely harder to get approved for a mortgage or mortgage refinance. Often times, it’s a red flag to lenders that you’re a high-risk borrower and you might not be able to pay back the loan.
With a poor credit score, you might even think that obtaining a mortgage or refinancing one simply isn’t an option.
The good news is there are options out there to refinance your home with bad credit, including one that might be the best fit for your situation — cash-out refinancing.
What is Cash-Out Refinancing?
Most people know that a mortgage is a type of loan specifically used to ‘pay’ for a home or another type of property. They’re offered by banks, financial institutions, and private lenders and often backed by the U.S. government.
Many people — especially first-time homebuyers — opt for government-backed loans because they’re more affordable, offer lower interest rates and are usually much easier to qualify for than conventional loans.
Consequently, many homeowners later look to refinance and obtain new loan terms down the road. (And yes, you can definitely refinance a government-backed loan, according to the Federal Housing Administration’s own handbook).
A ‘cash-out refinance’ is used to facilitate a brand-new mortgage that converts your home’s equity into cash. You simply take the current amount still owed on the loan, plus the amount of cash you’d like at closing, and combine them. That total, once approved, is your new mortgage principal.
What is a ‘Bad’ Credit Score?
When you apply for credit or a new loan, banks and lenders need a way to determine whether or not to let you borrow that money. In the U.S., the three national credit bureaus (you likely know them as Experian, Equifax, and TransUnion) compile, update and report on your credit history. From there, A FICO Score emerges, which is a three-digit number based on the information from those three bureaus.
Your FICO/credit score helps lenders to make a decision on how likely you are to repay a loan. It will ultimately affect how much you can borrow, the time you’ll have to repay the money, and the interest rate (or how much it will cost you to borrow, overall).
Your credit score can range from 300 to 850, with a score between 300 and 579 considered to be very poor. A score between 580 and 669 is considered fair, and a number falling between 670 and 739 is good. Very good to exceptional scores run from 740-799 and 800 to 850.
Bad Credit? Here’s How You Can Still Qualify For A Cash-Out Refi
Borrowers with poor credit can still obtain home loan refinancing. In fact, Experian says a cash-out refinance might be a better option for homeowners with bad credit. Here’s why:
- Any cash-out refinance replaces the existing mortgage loan, thereby satisfying the original mortgage. While not quite a gold star on your credit report, it still earns solid remarks.
- Because lenders are facilitating a new mortgage, they are the first party lien holder. In the event you default, they have means to recoup their investment.
- The cash-out deal also sets money aside that homeowners can use to pay off other existing debt, such as a car loan or high-interest credit cards. Paying down debt and doing so on time only helps your credit score.
Criteria will typically vary from one bank or mortgage company to the next, but chances are that you can meet a lender’s minimum requirements to do a cash-out refinance.
Your Options for a Cash-Out Refinance With Bad Credit
There are a number of different options available if you’re looking to get approved for a cash-out refinance with bad credit. Unfortunately, a conventional loan is probably out of the question and off the table. Instead, an FHA loan designed for those with fair to poor credit should be one of the products you’re looking at.
In order to qualify for an FHA cash-out refinance, borrowers need at least 20 percent equity in their home based on a new appraisal. (Again, equity, in this case, is the difference between the current value of the home and the amount still owed on the original mortgage).
According to updated FHA guidelines, applicants need to have a minimum credit score of 580 to qualify for an FHA cash-out refinance. However, most FHA- insured lenders set limits higher, since cash-out refinancing is also subject to a thorough underwriting process.
Additionally, documentation is required to prove that you’ve made on-time payments on your mortgage for a period going back at least 12 months, or since the time you obtained the loan, whichever is less. You must have a minimum of 6 months of payments made before you’re eligible to refinance.
Other options might include a cash-out refinance with Fannie Mae or Freddie Mac, but eligibility is also based on established criteria with the lender.
If you’re a U.S. military veteran and you’re eligible for VA financing, you may be able to negotiate a cash-out refinance of up to 90% of your home’s value — even if you have poor credit.
A Cash-Out Refinance With Bad Credit Is Not Impossible
If you have bad credit, there are steps you can take to get your score above a certain threshold and keep it there. Paying down debt is imperative, as the total amount that you owe — which includes mortgages, credit card bills, car loans, student loans, and other debts — is one of the major elements of how your credit score is calculated.
Another factor is your payment history, which is always given the greatest weight. Missing what would otherwise be an on-time payment by just a few days can label you as ‘delinquent’ and seriously impact your credit score.
If you’re serious about cash-out refinancing with bad credit, it’s best to find a financial advisor or licensed loan officer and look at your options and the credit requirements. In most cases, it’s best to focus on building up your credit score before you attempt to refinance. Once you’ve done that, your process should be hassle-free and similar to applying for your original loan. You’ll find the lender you want to work with, make sure you fit their qualifications and apply. The goal is getting that closing disclosure that includes your new loan terms and the costs you need to cover. After that, it should be smooth sailing to your closing day.
- Can an FHA loan be refinanced later on down the road?; FHA Handbook. Accessed from http://www.fhahandbook.com/blog/can-fha-loan-be-refinanced/
- Can you get a cash-out refinance with bad credit?; Experian. Accessed from https://www.experian.com/blogs/ask-experian/can-you-get-a-cash-out-refinance-with-bad-credit/
- What is a FICO Score?; My Fico. Accessed from https://www.myfico.com/credit-education/what-is-a-fico-score
- Defining bad credit, Investopedia. Accessed from https://www.investopedia.com/terms/b/bad-credit.asp
- FHA cash-out refinance mortgages, FHA.com. Accessed from https://www.fha.com/fha_refinance
- VA cash-out refinance, Veterans United. Accessed from https://www.veteransunited.com/refinance/cashout/