Qualifying for a Cash-Out Refinance with Bad Credit

The proceeds from a cash out refinance loan are used to pay off the existing loan and the remainder can be applied to any other obligation or for other purposes.  The refinance also helps create more favorable loan terms for the borrower and possibly lower interest rates.

How Cash Out Refinance Loans Work

A cash out refinance loan is based on the difference between the equity in the home and the balance of the existing mortgage loan. For example, a borrower with a $200,000 mortgage with an outstanding balance of $80,000 will have of $120,000 to borrow. Borrowing up to the available equity allows the homeowner to pay off the existing mortgage and use the difference for other reasons. The cash-out transaction should provide a homeowner with lower  monthly payments and better interest rates. 

The Impact Credit Ratings have on Cash Out Loans

Lenders tend to give more favorable interest rates to borrowers with high credit scores, as measured by the Fair Isaacs Corporation (FICO) rating service.  A score in excess of 720 and higher will receive better rates than those in lower FICO score brackets.

A financial institution that provides mortgage loans may consider borrowers with lower credit scores or bad credit if there is sufficient equity in the property to offset the credit risk. A lender will  review the amount of equity and will typically lend a lower loan-to-value for bad credit. For example, a FICO score of 600 will have a loan to value maximum of 85 percent and a 760 FICO score will have a maximum of 95 percent.

Higher Interest Rates for Bad Credit Borrowers

Also, lenders will impose a higher interest rate on loans to borrowers with bad credit. Again, this protects a lender against a risk of loan default.  A borrower with a higher FICO score can see a 2 to 4 rate improvement on a cash out refinance. The requirements established by lenders vary, and the borrower should understand the terms and conditions of a lender in order to determine whether the loan represents the best offer for them.