What are the best mortgage programs for a cash out refinance if you have a low credit score?

By Michael Jensen, Mortgage and Finance Guru

Edited by Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Updated October 20, 2020

There are multiple financing options for applicants with a low credit score that want to take cash out of their homes. The program that is right for you depends on your personal situation and financing goals. We review the best cash out refinance options for credit-challenged applicants so you can select the program that meets your needs.

FHA Cash Out Refinance. If you want to do a cash out refinance and you have a low credit score then the FHA Cash Out Refinance is your best mortgage option in most cases. The FHA Cash Out Refinance Program requires a credit score of only 500 for most applicants, which is significantly lower than other conventional and government-backed loan programs.

An FHA Cash Out Refinance permits a maximum loan-to-value (LTV) ratio of 80% for a one-to-four unit property as long as you live in one of the units. This means if your property is valued at $100,000, your maximum mortgage amount is $80,000.

You are required to pay off any existing mortgages or other loans on the property before you receive any proceeds from the cash out refinance. For example, if you qualify for a $80,000 cash out refinance on a property with a $60,000 mortgage, the maximum amount of proceeds you can receive is $20,000, less any closing costs you are required to pay.

Use ourCASH OUT REFINANCE CALCULATORto determine the proceeds you can take out of your home

The main negative of an FHA Cash Out Refinance is that you are required to pay an upfront and monthly mortgage insurance premium (MIP) which increases your closing costs and monthly housing expense. The ongoing FHA MIP is non-cancellable in most cases which means you are required to pay it as long as the mortgage remains outstanding.

The FHA Program also applies loan limits which cap your maximum mortgage amount. The loan limits vary by county and the number of units in the property.

Offsetting these considerations, the interest rate for an FHA Cash Out Refinance is typically lower than the rate for a conventional cash out refinance. Paying a lower rate reduces your monthly payment, increases the mortgage you can afford and reduces your interest cost.

The table below shows FHA mortgage rates and fees for leading lenders in your area. We recommend that you contact multiple lenders to learn more about FHA Cash Out Refinance Program guidelines and to find the best loan terms.

Conventional Cash Out Refinance Program. If the FHA Program does not work for you or you want to avoid paying MIP, you should consider a conventional cash out refinance program. Although this program offers certain benefits, the qualification requirements are more challenging.

The minimum credit score required to qualify for a conventional cash out refinance is usually 640, depending on your LTV ratio and other factors. This score requirement is significantly higher than the FHA Program.

The maximum LTV ratio for a conventional cash out refinance of a single unit owner occupied property is 80% and 75% for a two-to-four unit property. For an investment property, the maximum LTV ratio is 75% for a one unit property and 70% for a two-to-four unit property.

We should highlight that the conventional cash out refinance program applies to both owner occupied and investment properties whereas the FHA Cash Out Refinance Program does not permit investment properties.

Another positive of the conventional cash out program is that you are not required to pay mortgage insurance as long as your LTV ratio is 80% or lower. This reduces your closing costs and monthly payment.

The conventional cash out refinance program is provided by traditional lenders such as banks, mortgage brokers and credit unions. We recommend that you contact multiple lenders in the table below to compare refinance terms.

VA Mortgage Program. The final option for a cash out refinance for eligible applicants is the VA Mortgage Program which is available to eligible active duty military personnel, veterans and members of the national guard. Although technically the VA Program does not apply a minimum credit score guideline, most lenders require a score of at least 620 to qualify.

The VA Program also permits a maximum LTV ratio of 100% which means your mortgage amount can equal the appraised fair market value of your home. Using a higher LTV ratio enables you to take out more proceeds with a cash out refinance.

The VA Mortgage Program requires most applicants to pay an upfront VA funding fee which is similar to mortgage insurance for other types of loans. The funding fee may be higher for a cash out refinance.

The good news is that VA mortgage rates are usually lower than conventional loan rates because the program is insured by the government. The table below shows VA mortgage terms. As always, we advise you to shop multiple lenders to find the lowest rate and fees.

Sources

"II.A.8.d.v. Cash-Out Refinances."  FHA Single Family Housing Policy Handbook 4000.1.  Federal Housing Administration, January 2 2020.  Web.

"B2-1.3-03, Cash-Out Refinance Transactions."  Selling Guide: Fannie Mae Single Family.  Fannie Mae, July 3 2019.  Web.

"VA-Backed Cash-Out Refinance Loan."  VA.  U.S. Department of Veterans Affairs, 2020.  Web.