Just having a mortgage and some home equity doesn’t necessarily guarantee approval if you decide to apply to refinance your mortgage.
If your credit score has dropped since you were approved for your current mortgage, lenders may deny your application.
Fortunately, if you need to refinance before you have a change to improve your bad credit, you have a few options.
What it means to refinance your mortgage
Refinancing your mortgage replaces your current mortgage with a new one, which ideally has better terms.
Although breaking your existing mortgage to refinance may incur prepayment penalties, legal fees and an appraisal fee, it could be worthwhile if it helps you save money in the long term or access cash for more immediate needs.
Mortgage refinancing eligibility
Qualifying for mortgage refinancing is just like qualifying for a new mortgage. Even if you qualified for your current mortgage only a few years ago, you’ll need to go through the process again. Lenders will typically check your:
- Proof of income, such as proof of employment and tax returns.
- Debt service ratios, including other financial obligations such as car loans.
- Credit score and history.
As part of this process, lenders will check to see if you pass the mortgage stress test, which evaluates your finances against a higher qualifying rate.
Your qualifying rate is either 5.25% or the rate you’ve negotiated with your lender plus 2%, whichever is higher. For example, if your lender offers you a rate of 6.54%, you’d need to be able to qualify at a rate of 8.54%.
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Options for refinancing a mortgage with bad credit
A low credit score can be a major obstacle to refinancing your mortgage.
Even if you have a high income and have built enough equity in your home, the Big Six banks or other ‘A lenders’ may not approve your mortgage application because they may be concerned about your ability to repay the loan. Alternatively, they may approve you but with a higher interest rate than you may have expected based on the posted rates.
If A lenders are off the table due to your credit score, you can consider refinancing with:
- B lenders. Monoline lenders and alternative lenders, often referred to as ‘B lenders’, may have more relaxed qualification requirements. The interest rate you’re offered by a B lender will depend on your individual situation, but may be higher than the rates you see advertised by traditional lenders.
- Private lenders. You can also consider borrowing from private equity firms, mortgage investment corporations or individuals. These lenders typically charge the highest interest rates but have the most relaxed qualification requirements.
Frequently asked questions about refinancing a mortgage with bad credit
When refinancing your mortgage, you can typically borrow up to 80% of the appraised value of your home. However, you need to deduct your outstanding mortgage balance and any other loans you have secured against your home, such as a home equity loan or home equity line of credit (HELOC).
For example, say your home is worth $700,000. Technically, you could qualify to borrow up to $560,000. However, if you have $500,000 remaining on your existing mortgage, you’d only be able to access $60,000 of your equity through a refinance.
Nerdy Tip: You don’t have to borrow against your equity when refinancing your mortgage — it’s just an option. Some homeowners refinance just to take advantage of lower interest rates and pay less for their mortgage in the long run, or to get better mortgage terms.
Generally, a higher credit score helps make it more likely that you’ll be approved for a mortgage refinance, and get the most competitive interest rate. Most banks don’t publish a specific credit score required, but understanding the general classification of scores can help. Although credit score models differ depending on the credit reporting agency, generally, a credit score of 660 to 724 is considered good, 725 to 759 is very good, and above 760 is considered excellent.
Pros and cons of refinancing with a bad-credit lender
The benefits of using a non-traditional lender will depend on your financial situation as well as the lender you choose. Generally, you’ll want to consider the following pros and cons before deciding.
Pros of using a bad-credit lender
- Easier to qualify. Non-traditional lenders typically have lower qualification criteria compared to A lenders.
- Can be a good temporary solution. Having bad credit or low income might just be a temporary problem. B lenders could provide a short-term solution until you qualify with a traditional lender.
- Sometimes the only solution. If you’ve been declined by traditional lenders, a non-traditional lender may be your only choice.
Cons of using a non-traditional lender
- Higher lending costs. Non-traditional lenders typically charge a higher interest rate.
- Shorter terms. When getting a mortgage with a B lender, the term is typically one to three years. The expectation is that your finances will improve during that time, so you’ll be able to get a mortgage with a traditional lender.
Mortgage renewal is an opportunity at the end of a mortgage term to negotiate the conditions of your contract, such as the interest rate, payment schedule and more.