You have bad credit so you assume your chances of a cash-out refinance are gone. This may not be the case, though. You may have options. It involves shopping around. You may also need a co-signer or compensating factors. We’ll walk you through the steps to see if you too can tap into your home’s equity.
How Bad is Your Credit?
First, look at your credit. How bad is it? Can you fix any of it? You can’t change the past, but you can change the future. Start paying your bills on time and take care of collections. If you filed for bankruptcy or had a foreclosure, get your credit back on track.
If your score is around 620, you may still have luck, though. This doesn’t mean that you shouldn’t take care of your credit. Everyone could use to brush up on their credit scores. But, lenders offer options to those who have a credit score near 620. Anything lower and you might have to do some repair before you can apply.
Have an Explanation Ready
Something almost any lender will want is an explanation for the bad credit. What happened? Was it circumstances outside of your control? If so, provide it. Maybe you lost your job or fell ill. You can prove the loss of income with your W-2s. You can prove your illness with medical records. These things show the lender that you didn’t do this on purpose. Most importantly, they see that you just aren’t financially irresponsible.
Shop for a Subprime Lender
The real trick is where you shop. Don’t assume the big name lenders will give you a loan. They usually deal with conventional and government-backed loans. Certain government-backed loans may be an option, depending on how bad your credit is. But then you’ll have to pay the upfront mortgage insurance or funding fee. It’s up to you if the cost is worth it. If not, shop for a subprime lender.
This is a lender that keeps the loans on their books. They underwrite and fund the loan. They don’t sell it to the secondary market. The only answers you have to give are to the lender themselves. This allows the lender to make or even break their own rules.
Come Up With a Reason
You’ll need a good reason as to why you need the cash-out refinance. Are you repairing your home? Maybe you need an addition on the home due to an expanding family. The lender may see these as positive changes. They’ll figure out how much the home might appreciate with the changes. This is a compensating factor. It decreases the lender’s risk because they know they have your home as collateral.
If you need the cash for debt consolidation, talk to your lender about it. If they know you’ll pay off specific debts, they can figure it into your debt ratio. This could help your case, especially if you let the lender pay the creditors off with the loan’s proceeds.
Sometimes you need cash for reasons unrelated to your home or your debt. Again, let the lender know why you need the funds. The more open and honest you are about the situation, the better your chances of approval. If you need the funds for a one-time event, such as a wedding or vacation, the lender might be understanding. It also shows them that you aren’t going to consistently need funds – it’s a one-time occurrence.
Show Off Compensating Factors
Your credit isn’t the only thing lenders care about. They’ll look at other factors too. The most important are your debt ratio and the loan-to-value ratio. Either of these can help you sway the lender’s mind. Let’s say you have a 28% front-end debt ratio and a 34% back end ratio. These are lower than the conventional requirements. This could serve as a compensating factor. The less debt you have, the more likely you are to pay your mortgage.
The same is true for your loan-to-value ratio. The more you borrow compared to the home’s equity, the riskier you become. A lower LTV can serve as a compensating factor, though. It shows the lender that you have more invested in the home. In a lender’s eyes, this means you’re more likely to pay your mortgage.
Other compensating factors include:
- Several months of reserves on hand (Money you can use to make your mortgage payment)
- Stable employment (Holding the same job for many years)
- Increasing income (Income that steadily increases year after year)
Each lender looks at compensating factors differently. If one lender doesn’t approve your loan, but you have factors to make up for your bad credit, keep shopping.
Get a Cosigner
As a last resort, you might want to ask someone to cosign the loan with you. Generally, the cosigner doesn’t have to live with you. They just need better credit than you. If they agree to be responsible for the loan should you default, the lender may use this to your advantage.
Many lenders out there will write a cash-out refinance for people with bad credit. You just have to find ways to make yourself look less risky. Lenders don’t focus solely on credit scores. They look at the big picture. It’s up to you to make that big picture pretty. As a worst-case scenario, you can ask someone to be your cosigner. Just make sure it’s someone that trusts that you will make your payments so it doesn’t become a complicated situation.
Again, make sure you shop around with different lenders. Each subprime lender has a different program they can offer. Compare the rates and costs. Look at the big picture before you decide which loan is right for you.