How to Get a Home Equity Loan With Bad Credit
- To get a home equity loan with bad credit, you’ll need significant home equity and a good source of income.
- Home equity equals your current home value minus your current mortgage balance.
- Expect higher interest rates and loan fees when you have bad credit.
Table of Contents
You might be able to borrow with a home equity loan even if you have bad credit. Home equity lenders consider the overall strength of your application, including your income stability, recent credit history, debt-to-income ratio, and your loan-to-value (LTV) ratio. Here are the terms and interest rates you can expect when you apply for a home equity loan with bad credit.
Credit Score Needed for a Home Equity Loan
Eager to learn how to qualify for a home equity loan when you have a less than satisfactory credit score? It can be tricky, the pros concur.
“A FICO credit score below 620 is considered bad credit for a home equity loan,” notes Lyle Solomon, a financial expert and attorney in Rocklin, California. “Many lenders may issue a loan if your credit score is between 620 and 699, but if your credit score is 580, you will face a tough time.”
Christopher Liew, a chartered financial analyst and founder of Wealthawesome.com, agrees.
“You need a credit score of at least 620 to qualify for most home equity loans. You can do this by limiting your credit utilization ratio to 30%. Your credit utilization ratio computation affects 30% of your overall credit score, surprisingly,” Liew says. “This is why you should never max out on your credit limit.”
How to Qualify for a Home Equity Loan With Bad Credit
Although it will be difficult, it’s still possible to qualify for a home equity loan with bad credit, according to Tiller.
“If you have a credit score below the minimum, some lenders may look at other requirements, such as a stable job with high income and high home equity accrued. They may also look at your payment history – so paying your bills on time can greatly help,” he says.
You can work to improve your chances for home equity loan approval by reducing your debt-to-income (DTI) ratio to 43% or less.
“Your DTI will help lenders determine how much you can afford to borrow and if you can repay it. Aim to have a DTI of 40% or lower, if possible,” Ahren Tiller, founder and supervising attorney for Bankruptcy Law Center in San Diego, recommends.
To calculate your DTI, add up all of your monthly debt – including loans, credit card payments, and any other financial obligations. Next, divide this by your monthly gross income.
One factor that can help compensate for poor credit is having sufficient equity built up in your home. Home equity lenders want to see a low LTV ratio if you want a home equity loan when you have bad credit. LTV equals the total loan against your home divided by its current value.
If your house value is $200,000, your mortgage balance is $100,000 and you want a $50,000 home equity loan, your LTV is $150,000 / $200,000. That’s .75 or 75%. So after taking out a home equity loan, you’s have 25% equity (100% - 75% = 25%).
The lower your credit scores, the more equity you’ll need to get approved for a home equity loan with bad credit.
“Maintaining at least 20% equity in your house is also critical in case the real estate market suffers a downturn in the value of your home drops to a level that is substantially lower than the outstanding balance on your mortgage,” Solomon points out. “Consider that selling your property may be more challenging if you have used up all of your available credit.”
There are other steps you can take to enhance your creditworthiness and improve your eligibility for a home equity loan, too.
“Check your three free credit reports and identify any areas you need to work on. Contact Equifax, Experian, and TransUnion to remove any errors and take steps you spot, including loans you don’t have or other concerns, such as past-due payments,” Solomon suggests.
If your credit is too weak to qualify for a home equity loan, consider getting a cosigner or co-borrower who has a good credit score.
“This cosigner will apply for the home equity loan with you and will be required to make payments if you default on the loan,” adds Solomon.
Be aware that, even with a cosigner, you’ll still need to meet the minimum credit requirements to qualify for the home equity loan according to the lender’s underwriting guidelines.
Where to Get a Home Equity Loan With Bad Credit
You can apply for a home equity loan, even if you have bad credit, with many online and brick-and-mortar lenders, banks, and credit unions.
“It can be challenging to locate lenders ready to provide you with a loan if you have bad credit. That’s why it’s critical to shop around and acquire quotations from different lenders, particularly because the interest rate you can expect to pay will be higher with a poor credit score, and getting the best rate possible will save you a lot of money in the long run,” Solomon continues.
When thinking about where to get a home equity loan with bad credit, don’t forget your existing lender.
“If you currently have a mortgage loan with them, they should have first-hand experience with you being a good customer. This will be taken into consideration in their underwriting model,” explains Rhett Roberts, CEO/product director for LoanPro in Farmington, Utah. “Nearly every lender has a customized underwriting model to consider repeating customers.”
Some lenders don’t specify minimum credit score requirements as part of their home equity loan application process. These include Flagstar Bank, Third Federal Savings & Loan, Citizens Bank, Fifth Third Bank, and KeyBank, notes Mkrtchyan.
What Interest Rates Can You Expect When You Have Bad Credit?
Rita Mkrtchyan, a senior attorney and Payday Loan Equity Alliance Member at Oak View Law Group in Glendale, California, says the lower your credit score, the less likely you will qualify for a home equity loan and the higher your interest rate will be.
“For instance, according to FICO.com, a borrower with a credit score between 620 and 639 would pay an average interest rate of 10.88%, $561 monthly, for a 15-year fixed home equity loan of $50,000. That’s more than double the interest rate of a borrower with a top-tier credit rating,” she says. “But if your FICO score is between 740 and 850, you’ll likely get an interest rate around 4.78% and have a monthly payment of only $390.”
Per the Fair Isaac Corporation (FICO), here are the interest rates and monthly payment you can likely expect, depending on your credit score (based on national averages), if you were to borrow $50,000 via a 15-year home equity loan*:
|FICO score||APR||Monthly payment|
*These estimates are subject to change; interest rates can fluctuate
Other Ways to Help Qualify for a Home Equity Loan with Bad Credit
To improve your chances of qualifying for a home equity loan, strive to up your credit score and reduce your debt relative to your income (debt to income ratio, or DTI). You calculate your DTI by first adding up all of your debt payments – mortgage, credit card minimums, auto loans, etc. Then, you divide that total by your gross (before-tax) income. Lenders prefer DTIs under 43%.
“This will take time, consistency, and discipline,” cautions Mkrtchyan. She advises the following steps:
Check your credit report to see if there are any errors, such as lines of credit you didn’t open or other issues like overdue payments.
Pay your bills on time every month. “At the very least, make the minimum payment but try to pay off the balance completely,” Mkrtchyan adds.
Don’t close credit cards after you pay them off. “Either leave them alone or have a small, recurring payment every month. Closing credit cards reduces your credit utilization ratio and can cause your credit score to dip,” Mkrtchyan says.
Don’t max out or open new credit cards. This will result in a high credit utilization ratio, making you look like an irresponsible credit user.
Pay down existing credit card debt to stay below the recommended 30% utilization rate.
If you get turned down by one lender, don’t despair. Work to up your credit score and apply with other lenders and banks, which may grant loan approval.
“Bad credit is not the end-all. You simply have to take additional steps and research different lenders,” adds Mkrtchyan.
Will I be able to refinance a bad credit home equity loan when my credit improves?
Paying a home equity loan (and your other bills) on time should help improve your credit score in a few months. And if you use your home equity loan to consolidate credit card debt, your score could climb quickly – if you pay your cards off in full each month. So check your credit report and score every few months, keep track of current home equity loan interest rates, and prepare to refinance when you can get better home equity loan terms.
What are home equity loan alternatives?
If you have bad credit, a lot of home equity, and you’re 62 or older, a reverse mortgage could get you out of a financial jam. Bad credit is less of an issue for reverse mortgage lenders because borrowers don’t have to make payments. Borrowers with bad credit pay the same or nearly the same interest rate as borrowers with good credit.
Another alternative, if you don’t have enough home equity for a loan, is a personal loan. It’s not easy to get a personal loan with bad credit, but you may be able to if you have collateral like a car or if you get a co-signer or co-borrower.
And if you don’t need to borrow a lot of money, a home equity line of credit (HELOC) might be a better solution. They usually have lower closing costs, and you only pay interest on the credit that you use.
Are there drawbacks to a home equity loan?
Home equity loans are mortgages. Mortgages are loans secured by real estate, and if you don’t make your payments as agreed, your lender can foreclose, evict you and sell your home. So don’t borrow against your home equity without a very good reason, and make sure that you can afford the payments.