How Credit Rating Affects a Cash-Out Refinance

A cash out refinance loan allows a borrower to take advantage of the equity in a home and use the difference to pay off the existing loan and use the proceeds for other purposes. This includes paying off other debts, medical bills and any other obligations of the borrower. The cash out refinance results in a new loan obligation by the borrower that has to be paid off.

Credit Rating Impact on Loan Qualification

A borrower’s credit rating impacts a borrower in their ability to qualify for a loan and the amount of interest they pay. A borrower with a high credit rating, typically in the mid 700s or higher based on the Fair Issacs Corporation (FICO) scoring system has a better opportunity for a favorable loan as opposed to a borrower with a low, poor or bad credit score.

Credit Rating Affect on Loan Interest Rates

Additionally, borrowers with higher credit scores receive a lower interest rate based on the current London Interbank Offered Rate (LIBOR) than those borrowers with lower credit scores. The difference in interest rates can be significant per every $100,000 borrowed. For example, a borrower with a $750,000 mortgage loan at 5 percent has a simple interest of $37,500 or $105 per month for a 30-year mortgage. Raising the interest rate 2 points to 7 percent adds $40 to the monthly cost or $15,000 in additional interest costs. Borrowers with bad credit who are approved for a loan can expect to pay an even higher difference.

All of this has to plenty to do with a cash out refinance loan. This is because although a cash out refinance results in the borrower receiving the difference that between the outstanding loan amount and the home’s equity, the transaction is still a loan that must be paid back. Credit ratings are one of the financial underwriting considerations a lender takes into account in order to determine loan rates, terms and conditions.  

Understanding Credit Rating

A borrower interested in applying for a cash out refinance loan should understand what their current credit rating is. This can be done by requesting current copies of their free credit report from the 3 major credit reporting bureaus (i.e. Equifax, Experian and TransUnion) as required under federal law. Understanding credit and making any necessary changes or corrections will help the borrower obtain the best loan possible. Not understanding or controlling credit will result in higher interest rates and charges connected with a cash out refinance loan.