Can You Do a Cash Out Refinance With Bad Credit?

A cash-out refinance allows homeowners to replace their existing mortgage with a new, larger one, receiving the difference in cash. Many homeowners consider this option to access their home equity, but they often wonder if it is possible with a less-than-perfect credit history. While a lower credit score presents challenges, a cash-out refinance is not always impossible.

Credit Score Considerations

Credit scores play a significant role in mortgage lending, including cash-out refinances, as they indicate a borrower’s creditworthiness. Lenders typically categorize credit scores, with those below 620 often falling into the “subprime” or “near-prime” range. For conventional cash-out refinances, a minimum credit score of 620 is generally required.

Government-backed loans, such as those from the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA), offer more flexibility. FHA cash-out refinances may be available with credit scores as low as 500 or 580, depending on the lender and specific program. VA cash-out refinances also tend to have lower credit score requirements, with some lenders approving scores in the 550 to 580 range, though the VA itself does not set a minimum. A lower credit score often translates to higher interest rates and less favorable loan terms, reflecting the increased risk perceived by lenders.

Other Lender Evaluation Factors

Beyond credit scores, lenders assess several other financial metrics for a cash-out refinance. The loan-to-value (LTV) ratio is a crucial factor, representing the loan amount compared to the home’s appraised value. Lenders typically require a maximum LTV of 80% for conventional and FHA cash-out refinances, meaning borrowers must retain at least 20% equity in their home. VA cash-out refinances can be an exception, sometimes allowing LTVs up to 90% or even 100% for eligible military homeowners.

The debt-to-income (DTI) ratio compares monthly debt obligations to gross monthly income. Many lenders prefer a DTI no greater than 43% for conventional loans, though some may approve applicants with DTIs up to 50%. FHA and VA loans can also accommodate higher DTI ratios, potentially up to 50%, providing more options for borrowers with elevated debt levels. Lenders also scrutinize income stability and documentation, requiring verifiable income through pay stubs, W-2s, tax returns, and bank statements to ensure the borrower’s ability to repay the new, larger loan. Property characteristics, such as its type and condition, can also influence lender decisions, with single-family homes generally offering more favorable terms.

Preparing for Your Cash-Out Refinance Application

Before submitting an application, review your credit report. You can obtain a free copy weekly from Equifax, Experian, and TransUnion through AnnualCreditReport.com. This allows you to identify errors that could negatively impact your score and understand the various factors contributing to your credit profile. Correcting inaccuracies can improve your credit score before applying.

Assess your home equity, as it directly impacts the cash you can access. Home equity is calculated by subtracting your current mortgage balance from your home’s estimated market value. You can estimate your home’s value using online tools or by consulting local real estate professionals.

Gather all necessary financial documentation in advance to streamline the application process. Lenders typically request pay stubs from the last 30 days, W-2s or 1099s for the past two years, and tax returns for the previous two years. Bank statements for the last two months are also commonly required. For self-employed individuals, bank statements or profit and loss statements may serve as alternative income verification.

Explore various lender options, as requirements differ among institutions. Traditional banks, credit unions, and mortgage brokers offer cash-out refinance products. Some lenders specialize in non-qualified mortgage (non-QM) loans, which may offer more flexible criteria for unique financial situations or credit challenges. Researching and comparing offers from multiple lenders can help you find the most suitable terms.

Navigating the Application and Underwriting Process

The formal application process begins after preparations. This involves filling out the lender’s application form and submitting all the financial documents you have gathered. Many lenders offer online application portals, which can simplify the submission of required paperwork.

After submission, your application moves into the lender’s review and underwriting phase. The lender evaluates all provided information, verifying employment, income, and assets to assess the overall risk. Underwriters scrutinize your financial profile to ensure you meet the specific eligibility criteria for the loan program.

A property appraisal is an important step in the process, ordered by the lender to confirm your home’s current market value. The appraisal helps determine the amount of equity available and, consequently, the maximum cash you can receive from the refinance. The appraiser conducts a visual inspection of your property and compares it to recent sales of similar homes.

Upon successful completion of the appraisal and underwriting, the lender will extend a loan offer outlining the proposed interest rates, fees, and other terms. The interest rate offered will be influenced by various factors, including your credit score and the overall financial situation presented in your application. Review these terms carefully, as closing costs for a cash-out refinance typically range from 2% to 6% of the total loan amount.

The final stage is the closing process, where you sign all necessary legal documents to finalize the loan. Cash-out funds are usually disbursed after a federally mandated three-day rescission period. This waiting period allows borrowers a final opportunity to reconsider the loan.