How to Get A Home Equity Loan With Bad Credit

Home equity loans let you leverage the equity you’ve built up in your home for a wide variety of purposes. Whether it’s financing that kitchen makeover your family needs or consolidating high-interest debt, this type of loan can be a simple, effective way of putting the money you’ve already invested in your home to good use.

If you have bad credit, however, qualifying for one of these loans might not be easy. Many mortgage lenders require minimum credit scores ranging between 620 and 700 — with most preferring 700 and above. Lenders also require that borrowers have between 15% to 20% equity in their home to qualify.

Having said that, if your credit score isn’t where you would like it to be, there are steps you can take to improve your odds of approval.

Read on to find out how you could qualify for a home equity loan, even with bad credit.

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Home equity loans and home equity lines of credit when you have bad credit

There are two main ways to leverage the equity you have in your home: home equity loans and home equity lines of credit (HELOCs).

Both of these let homeowners borrow an amount equivalent to approximately 85% of the equity they have in their homes, but they do so in different ways.

While home equity loans provide you with a lump sum that you’ll pay back in installments over a set amount of time, HELOCs are a type of revolving credit. This means you can borrow up to a pre-established credit limit during its draw period, and that credit becomes available again as you pay back what you’ve borrowed.

It’s important to note that both loans present a big risk: since your home serves as collateral, the bank could foreclose on it if you fail to pay back the loan.

Both types of loans have similar requirements and, while it might be challenging to qualify for these with a bad credit score, it’s not impossible provided you meet other criteria.

For example, banks that cater to borrowers with low credit scores might require a higher income, and therefore a lower debt-to-income ratio. They might also ask for a greater percentage of equity in the home, and will place higher interest rates than they would on loans to borrowers with good credit.

There’s no such thing as a “guaranteed” home equity loan when you have bad credit

The truth is that if you have a poor credit history, approval for a home equity loan or a line of credit is anything but guaranteed.

Not all lenders are equally trustworthy though, and some have been known to make those types of promises in an effort to entice borrowers who have been turned down by traditional financial institutions.

If a lender seems to promise approval regardless of your credit history, you should consider that a red flag. Legitimate banks will not guarantee approval, even to borrowers with excellent credit histories.

Can you get a home equity loan with bad credit?

The short answer is: it depends.

If your FICO score is between 620 and 700, you could probably qualify with some lenders, provided you have enough equity in your home and a high income.

Although lenders typically only approve borrowers who have 15% to 20% equity in the home, if your score is lower than 700, many lenders will require you to have at least 20%.

In addition to your credit score and equity, lenders will also consider your income and debt-to-income (DTI) ratio. This is the percentage of your monthly gross income that goes toward paying your existing debt.

Many lenders will set a maximum of 43% DTI as a requirement; although if you have a low credit score, some lenders might ask for a much lower percentage.

Can I get a HELOC with bad credit?

Much like home equity loans, most HELOC lenders require minimum credit scores in the 620 to 700 range, at least 15% to 20% equity in the home and a maximum DTI of 43%.

One thing to consider, however, is that, unlike fixed-rate home equity loans, HELOCs typically feature variable interest rates. This could make your payment change over time, making it harder to budget for.

If you’re applying for a HELOC and you have bad credit, it’s important to remember that lenders will probably offer you their highest interest rates, and that those might become even higher over the life of the loan.

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How to qualify for a home equity loan with bad credit

While it’s not easy to qualify for a home equity loan or a home equity line of credit if you have a low credit score, it’s not impossible either. Here are some steps that could help you increase your chance of approval.

Step 1: Review your credit report

Examining your credit report carefully is an essential step before applying for any loan. Knowing exactly where you stand will help you focus on the lenders that cater to borrowers with your credit score and will better prepare you for any questions your prospective lender might raise.

But there’s another good reason to check your credit carefully. Credit reporting mistakes are more common than most people think, and it’s worth checking whether errors are dragging your score down.

Right now — and for the rest of the year — you can get free credit reports weekly from Annualcreditreport.com, the only government-approved website that provides free reports from all three credit bureaus.

Once you have your reports from all three bureaus (Experian, Transunion and Equifax), review them in detail, checking for any accounts you don’t recognize or negative items that should no longer be reported.

If you find mistakes or outdated information in your payment history, you can dispute the items with collectors or bureaus and get them removed from your report. Alternatively, if you find extensive inaccuracies, you could engage the services of a credit repair company, which can dispute the items for you. If that’s your case, check out our picks of the best credit repair companies to find the right one for you.

But, finally, if all the negative items in your reports are correct — and your credit score is 620 or less — we recommend you wait before applying. Focus on lowering your credit utilization ratio by paying down any credit card debt and making sure you pay any loans (especially your mortgage) on time. This could make a significant difference in your credit profile in the short term.

Step 2: Calculate your equity and loan-to-value ratio

To put it simply, equity refers to just how much of your home you own compared to what you still owe the bank. And, as we mentioned above, most banks will require you to have at least 15% to 20% equity in the home — maybe more if your credit is on the lower end of the minimum range required.

The first step in calculating your equity is to get your home professionally appraised. While you might be tempted to calculate the value of your home using a market value estimation website, this will never be as precise as a professional assessment.

Once you know your home’s appraised value, calculating your equity is simple enough: you subtract your mortgage balance from your home’s current market value. Say you owe $150,000 on your mortgage note and your home’s current appraised value is $250,000:

$250,000 – $150,000 = $100,000

In this example, your equity in the home is $100,000. To find out whether this amount is enough to qualify (that is, more than 15% to 20%), you can divide the amount of your equity by the appraised value of the home and multiply that by 100:

($100,000 / $250,000) * 100 = 40%

In this example, you’d have way more than enough of the equity percentage required by most banks.

Once you know your equity, you’ll get another important number: the loan-to-value ratio (LTV). The LTV is the opposite of your equity and shows just how much you still owe on the property — the higher your loan balance, the more reluctant banks will be to take on the risk of a loan. Most lenders look for LTVs of less than 80%, meaning that the borrower has at least 20% equity in the home.

If you don’t have enough equity in your home to qualify, there are some things you can do before you apply. If your financial situation allows you to, you can switch to making biweekly payments on your mortgage instead of monthly payments. (In other words, pay half your monthly balance every two weeks.) Because you’ll end up making at least two extra payments a year, you can reduce your mortgage balance — and thereby increase your equity — quicker.

You can also prioritize projects that speed up your home’s appreciation, that is, its gained value. According to many real estate experts, projects that improve your landscaping or modernize your kitchen and bathrooms can quickly increase a home’s value.

Step 3: Calculate your DTI (and reduce it if possible)

The debt-to-income (DTI) ratio is an indicator of how much of your income is already going towards paying existing debt. Banks use this percentage to gauge whether you can afford another loan payment.

You can calculate your DTI by dividing your monthly debt — such as student loans, personal loans, credit cards, auto loans, mortgages, etc. — by the amount you earn before taxes are deducted (your gross income).

For example, let’s say your gross monthly income is $4,000, and $1,400 of that goes toward debt payments. You’ll divide those amounts and then multiply the result by 100 to get a percentage:

($1,400 / $4,000) * 100 = 35%

Different lenders have different DTI ratio requirements; however, many look for a number around 35% or less, and will not approve anything over 43%. If your number is higher than that, it’s a good idea to work on reducing the ratio by paying down current installment loans before applying for a home equity loan or line of credit.

Also, take note that DTI just takes into account loan and credit card payments, not daily expenses such as rent, utilities or groceries. To calculate whether you can afford the new payment, make sure to take all your monthly expenses into account.

Step 4: Find a lender that accepts lower credit scores

The first step in finding a lender is to contact your current mortgage company since, often, borrowers face better odds with banks they already do business with.

However, if your current lender turns you down, there are other alternatives. There are plenty of great lenders that will consider applicants with credit scores in the mid- to low-600s.

Many of these are featured in our list of the Best Home Equity Loans, which includes:

Step 5: Use a co-signer

If your credit score is below what most lenders will consider, and you have someone willing to share responsibility, asking them to be a co-signer on your loan might be a good choice.

Also called a co-applicant or co-borrower, this person would be responsible for repaying the loan if, for some reason, you could not. This reduces the risk of default for the bank, which makes them more willing to approve the loan. In order to improve your chances of qualifying, your co-signer should have a stable income and a fair to excellent credit score.

For many borrowers with poor credit, getting a co-signer with a higher credit score can be the key to approval and/or better interest rates.

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Home equity loan alternatives

If you’ve decided that home equity loans or lines of credit aren’t the right choices for you, there are other loan options to consider.

Home equity sharing

Home equity sharing is a fairly new option in the home equity market. It’s a type of investment deal in which a borrower lets a company buy a portion of the equity in their home, in addition to a share of any changes to the equity in the future. In this type of arrangement, the homeowner pays the funds back as a lump sum when the term of the contract ends, they sell the home or buy out the investor.

Cash-out refinance

Cash-out refinancing involves replacing your existing mortgage with a larger one. The lender pays off the old mortgage with the new one and gives you the surplus as cash. This means you’ll start over again with a new mortgage, with different loan terms and interest rates.

Do note that the Federal Reserve has recently increased rates, which will affect the kinds of interest rates banks will offer. To check whether this is the right time to refinance, read our article on current mortgage rates. Additionally, learn more about the steps involved in refinancing your mortgage in this high-interest rate environment.

And, if you’re interested in this option, make sure to check out Money’s best mortgage refinance companies.

Personal loans

Unlike home equity loans and lines of credit, personal loans are unsecured loans — in other words, they do not require collateral. This means that you won’t lose valuable assets (like your home) if you default.

However, because they’re unsecured loans, they’re harder to qualify for when you have poor credit, as banks might not be willing to take the risk unless you offer a valuable asset as a guarantee.

But, if you’re able to qualify for an unsecured loan like this one, personal loans are good options, especially if you want to borrow smaller amounts and you want the money fast.

Reverse mortgage

A reverse mortgage is a type of mortgage that lets homeowners 62 and older borrow a lump sum of money, open a line of credit or receive monthly payments while using their home as collateral. Unlike a regular mortgage, borrowers do not have to make monthly payments to the lender. However, the amount they owe increases, not decreases, over time.

Reverse mortgages are repaid once the owner (and their spouse, if they’re a co-borrower) moves out of the home for longer than a year. If the owner dies before moving out, their heirs will have to decide whether to sell the home to repay the loan or surrender the title to the lender.

Our article, Reverse Mortgage Pros and Cons, has important information every homeowner needs to know before applying for this kind of mortgage.

Summary of Money’s How to get a Home Equity Loan with Bad Credit

• While it might be challenging to qualify for a home equity loan or line of credit when you have bad credit, there are steps you can take to increase your chances of approval.

• Most mortgage lenders have minimum credit requirements of anywhere between 620 and 700, although most will prefer 700 and above.

• Home equity loans provide a lump sum upfront, while HELOCs give you access to a credit line that you can tap into for a draw period (typically 10 years).

• These types of loans use the equity in your home as collateral, meaning there’s a risk of foreclosure if you default on the loan.

• Lenders will also require you to have a certain amount of equity in your home — typically at least 15% to 20%, but could require more from borrowers with bad credit.

• Bad credit home equity loans typically feature stricter approval requirements in other areas, such as a greater percentage of equity and/or higher income, among other things.

• To improve your odds of approval, you can: review your credit report and dispute any erroneous information, make sure you have enough equity in your home, reduce your debt-to-income ratio, find a lender that caters to borrowers with similar credit scores and/or apply with a co-signer if one is available.

• Some popular alternatives to home equity loans and lines of credit are home equity sharing, cash-out refinancing, personal loans and reverse mortgages.