The answer is ‘yes.’ Lenders want a ‘good’ credit score in order to ensure that you’ll make your payments on time. Taking cash out of the equity in your home means that you need to take a higher loan amount. Lenders typically don’t want to lend to borrowers that have ‘bad’ credit. If this describes you, there may be ways to get a cash-out refinance. Keep reading to learn how it’s done.
How a Cash-Out Refinance Works
First, let’s look at how a cash-out refinance works. You have the principal balance that you still owe on your mortgage. Let’s say you have a mortgage with a balance of $100,000 on it. If you want to refinance, you’ll need to pay that $100,000 loan off first. Let’s also say that your home is worth $200,000. So technically, you have $150,000 in equity in the home. Now you want to tap into that equity to use it for other purposes.
This is where the refinance comes into play. You need to apply for a refinance loan that is larger than your outstanding balance. Let’s say you want to take out $50,000 of your equity. You would apply for a loan amount of $150,000. As you can see, this is riskier for lenders. Your loan-to-value ratio just went from 50% to 75%. While that is still a low LTV, it puts the lender at higher risk for default.
Why You Need Good Credit
In order to lower the risk of default, lenders require a higher credit score. In general, you can expect the following minimum credit scores for cash-out refinances:
- Conventional loans – 680
- FHA loans – 600 (but most lenders require a higher score)
- VA loans – 600 – 620 (many lenders may require a higher score)
Again, each loan program requires these minimum credit scores. Each lender can create its own requirements, though, since lenders fund the loans. Many lenders look at the ‘big picture’ rather than just the credit score, though. We discuss this in detail below.
Compensating Factors May Help Your Case
When we talk about the ‘big picture,’ we talk about all of the qualifying factors that make up your loan application. Lenders look at your credit score alongside your debt ratio, employment history, income stability, and assets. If you have any ‘compensating factors’ or factors that go above and beyond the requirements, lenders may be more willing to accept a lower credit score.
Some of the most common compensating factors include:
- Low debt ratio – If you have a lower housing or total debt ratio than the program requires, lenders may look at you as a lower risk of default. If you don’t have excessive debts outstanding, the lender may feel as if they can count on you to make your payments even with your lower credit score.
- Stable employment – Lenders like to see you at the same job for at least two years. This shows them stability. You show the lender consistency, which is important when evaluating you for a loan.
- Increasing income – If you have income that steadily increased over the last two years that can help you qualify too. Showing lenders that you are continually trying to better yourself and work your way up the ladder makes you a lower risk of default.
- Reserves on hand – Most loan programs don’t require you to have assets on hand, but it can help your case if you do. Even though you are tapping into your home’s equity to get cash in hand, if you can prove that you have money set aside just in case you can’t make your mortgage payment, it can help your case.
Lenders take all of these factors and put them together. This gives them the ‘big picture.’ For example, a borrower with a low credit score, low debt ratio, stable employment, and reserves may still be a good candidate for a cash-out refinance. On the other hand, a borrower with a low credit score, high debt ratio, unstable employment, and no reserves wouldn’t be a good candidate.
Options for Those With Bad Credit
So what happens if you have bad credit and don’t have factors to compensate for it? Here are a few options:
- Cosigner – If you have a close relative that is willing to go on your loan with you and they have good qualifying factors, it could help you get qualified for the loan.
- Subprime loan – If you don’t have what it takes for a conventional or government-backed loan, consider a subprime loan. Subprime lenders can make their own requirements, which oftentimes are more flexible.
- Credit union – You may also find guidelines that are more flexible at your local credit union. Whether you have a credit union through your employer or any other group you belong to, they often have guidelines that are more flexible and even lower rates.
Other Options if You Can’t Refinance
If you find that you can’t get a cash-out refinance because of your bad credit, you have a couple of other options.
Home equity line of credit – This second mortgage works like a credit card. You get a credit line that you can use as you need. You only owe interest payments on the amount that you spend. If you pay the principal back, you can use the line again for the first 10 years. HELOCs often have more flexible guidelines, including low credit score requirements.
Home equity loan – This is also a second mortgage, but you receive the funds as a lump sum instead of as a credit line. You cannot reuse the funds even after paying back the principal and you’ll make principal and interest payments right from the start. Home equity loans often have guidelines that are more flexible as well.
Don’t give up if you need a cash-out refinance but have bad credit. There are ways to get the money you need, you may just have to be a little creative about it. Explore your options and create as many compensating factors as you can.Click to See the Latest Mortgage Rates»