How To Get A Home Equity Loan With Bad Credit
Whether you’re in the market for a first or second mortgage (also known as a home equity loan), one of the first things lenders will look at when determining your eligibility is your credit score. But your credit isn’t the only thing the best home equity loan lenders will consider when reviewing your loan application, and you can leverage those other factors to increase your chances of approval.
If you’re looking to get a home equity loan or home equity line of credit but your credit score leaves much to be desired, read on.
What is a bad credit score?
A credit score is a three-digit number lenders use to determine your creditworthiness, which is your likelihood of paying back what you borrow. Credit scores are based on consumers’ credit history as collected by different credit reporting agencies or credit bureaus. While there are others, the “big three” credit bureaus in the U.S. are Experian, TransUnion and Equifax. These companies compile your credit history in credit reports, which may vary from one company to the next.
Besides credit reporting companies, there are also different credit scoring companies, like FICO and VantageScore. When calculating credit scores, these companies use proprietary scoring models that consider factors such as consumers’ payment history and active credit accounts. FICO and VantageScore models are updated over time to include new credit data, so there are also different versions of both scores.
FICO and VantageScore credit scoring systems set a credit score range from Poor to Excellent. And whether you are deemed to have good or bad credit depends on where you fall on that scale. Here’s what those ranges look like for both companies:
| Credit score range | FICO Score ranges | VantageScore ranges |
| Excellent | 800–850 | 780–850 |
| Very good | 740–799 | N/A |
| Good | 670–739 | 661–780 |
| Fair | 580–669 | 601–660 |
| Poor | 300–579 | 300–600 |
Based on the above, a “bad” credit score falls in the 300–579 range in the FICO system and between 300–600 in the VantageScore system.
How to get a home equity loan with bad credit
According to Experian, FICO is the most popular credit score model in the mortgage lending industry. If you have a poor FICO credit score (one that’s under 580), qualifying for a conventional mortgage can be more difficult. In such cases, borrowers may find government-backed FHA, USDA and VA loans more flexible in their credit and income requirements. If you’re trying to get a home equity loan with a lower credit score, your options could be more limited.
Home equity loans — often called second mortgages — allow homeowners with tappable home equity to pull money out of their mortgage and use it for home improvements or other purposes. Lenders will look at other factors besides your credit score when determining your eligibility for this type of loan. If you can satisfy the other borrowing criteria, you can increase your chances of approval.
Requirements to obtain a home equity loan
Lenders that offer home equity loans will likely require the following.
- Credit score: Lenders generally require a credit score of 620 (in the fair range) or higher. If your score falls below that range, your ability to meet the lender’s other borrowing requirements could help tip the balance in your favor. Remember that the interest rate and the loan amount you may qualify for will partially depend on your credit score. Shopping around and getting loan offers from several different lenders (at least five, if possible) can ensure you get the best deal for your situation.
- Home equity: You may be able to borrow up to 80% of the equity in your home through a home equity loan or line of credit but to do that, you must first have a good amount of equity in your home (what’s called positive equity). Most lenders require you to have at least 20% equity to qualify for a home equity product. Since equity is the value of your home minus what you still owe on it, the loan process will entail a home appraisal.
- Combined loan-to-value (CLVT) ratio: To determine how much you could borrow through a home equity loan, lenders will look at your CLTV ratio or the total amount of loans secured by your home (the primary mortgage, second mortgages, etc.) divided by the appraised value of your home. A CLTV ratio under 80% is generally considered good.
- Debt-to-income (DTI) ratio: Your income and how much of it is tied up in debt payments is particularly important to lenders. Knowing how much you can afford to put toward your loan each month gives lenders a good idea of your ability to repay — or your likelihood of defaulting. To calculate your DTI ratio, divide your monthly debt obligations by your gross monthly income. Most banks and financial institutions that offer home equity products require a DTI ratio of 43% or less, but some lenders may accept up to 45%.
You may also have to provide proof of employment, income and other assets through past tax returns, pay stubs and bank statements. But, as with all loans, qualification requirements vary by lender. If you’re a freelancer or someone with variable income, know that some mortgage lenders are willing to consider alternative credit data.
Considerations before you seek a home equity loan with bad credit
If you decide to go through with a home equity loan application despite your credit issues, there are some things to keep in mind.
1. You might not get the most favorable terms
While you can get approved for a home equity loan with less-than-perfect credit, you probably won’t qualify for the lowest interest rate and the most favorable loan terms. The maximum amount you can borrow will depend on a combination of the factors mentioned in the previous section. With this in mind, working on your credit score could help you snag a lower interest rate and pay less for borrowing.
According to the Consumer Financial Protection Bureau, consumers trying to rebuild their credit should:
- Pay down their debt, starting with higher-interest debt
- Pay their bills on time (setting up automated payments could help)
- Stay below their credit limit and avoid maxing out credit cards
- Keep their credit card applications to a minimum
- Try getting a secured credit card instead of a regular one
- Pay their credit card balance in full each month
- Check their credit reports and correct any mistakes
This last point could be especially helpful if you haven’t read through your credit reports in a while. Any incorrect negative items on your reports could dent your score. You can request all three of your credit reports for free once a year at AnnualCreditReport.com.
While your credit reports won’t contain your credit scores, they can help you get a clearer picture of your credit situation and how to improve it. To get your credit score, consider a service like Credit Karma, which offers free scores based on the VantageScore 3.0 scoring model. Alternatively, several credit card issuers allow customers to access their FICO scores for free.
Applying with a cosigner could improve your approval odds if you need access to a home equity loan right away and don’t have time to work on your credit.
2. You can lose your home if you can’t pay your loan
Home equity loans and HELOCs are secured by your home. If you fail to repay your loan, you could end up with an underwater mortgage (owing more on your house than what it’s worth) or even losing your home to foreclosure.
If what led you to your current credit situation is related to missed payments, addressing your money habits could help you avoid repeating history. Even if you’re planning to use a home equity product to consolidate high-interest debt (such as credit card debt), consider credit counseling to complement your credit repair plan.
3. There are key differences between home equity loan options
Home equity loans provide borrowers a lump sum of money soon after closing. As they feature fixed interest rates, they’re generally recommended for borrowers looking to fund a one-time expense who want the predictability of fixed monthly payments. Not all lenders offer home equity loans, and those that do often advertise their products along with home equity lines of credit (HELOCs), which work differently.
HELOCs are often compared to credit cards because they allow borrowers to draw money as needed during a specified draw period and pay it back at a later time (called the repayment period). HELOCs typically have variable rates that can change depending on the prime rate, so your monthly payment could change from month to month. Some HELOC lenders allow borrowers to lock in a fixed rate for all or a portion of their line amount — for a fee.
The right home equity product for your needs will depend on how you plan to use your home equity and whether you’re comfortable with a fixed or variable interest rate. Again, keep in mind that your home equity loan or HELOC will be secured by your home, so make sure you opt for a product you can comfortably afford. Using a home equity calculator could help you make a better-informed decision.
Read our guide on HELOCs vs. home equity loans for more information. And for ideas on how to get the most out of your home equity loan, check out our article on the best ways to use home equity this year.
4. You’ll still have to pay closing costs and other fees
According to Experian, closing costs on home equity loans and HELOCs typically range between 2% and 5% of the loan amount. These charges could include origination, title search and appraisal fees, among others. Some lenders don’t levy closing costs on home equity products, but that may be contingent upon the loan or line of credit amount. Lastly, HELOCs may also be subject to annual fees, inactivity fees and charges for converting your line of credit from a variable to a fixed rate.
How To Get A Home Equity Loan With Bad Credit FAQs
As with all types of loans, the qualification requirements for home equity products vary by lender and loan amount, among other factors. Several of the best home equity loan lenders offer loans to applicants with credit scores in the 620 range.
If you have bad credit, meaning a credit score of less than 579, you may still qualify for a home equity loan or line of credit if you can satisfy other lender requirements. These could include having sufficient tappable equity, a combined loan-to-value ratio under 80% and a debt-to-income ratio under 45%.
The minimum credit score requirement for a home equity loan will depend on the lender. Several lenders we have reviewed require a minimum score of 620, while others require scores above 730. Keep in mind that lenders consider several factors in conjunction with your credit score, so you may still qualify with a lower score if you meet other qualification criteria.
Your home equity line of credit application can be denied if you don’t meet your lender’s qualification requirements. Keep in mind that while HELOCs and home equity loans are safer for lenders to issue because they are secured by your home, lenders will still verify your creditworthiness to determine your eligibility. You may also have to meet specific property requirements. For example, some lenders will not issue loans backed by properties that have structural or safety issues.
Credit repair companies review your credit reports and dispute incorrect negative items on your behalf directly with the credit bureaus. According to the Consumer Financial Protection Bureau, these companies charge a fee for their services, which can often be high.
If you’re thinking about hiring the services of a credit repair company, keep in mind that you cannot remove negative items that are correct from your credit report. Also, it may take time for your credit score to reflect any positive changes. Additionally, you can work on improving your credit score yourself without the need to hire a credit repair service.
The CFPB recommends being on the lookout for credit repair companies that don’t have customers’ best interests in mind. Here are some things to watch out for:
- Companies that demand payment upfront
- Guaranteed results and promises of increasing your credit score to a certain number or fixing your credit in a short period
- Companies that don’t disclose the total cost of their services don’t provide you a service contract and don’t inform you of your rights, including the right to cancel your contract within three business days
- Companies that suggest you create a new credit identity by applying for an employer ID number instead of a Social Security number
Your options will depend on your specific situation, but addressing the root of your credit issues can be a good way to break the debt trap cycle and start rebuilding your credit. That can entail revisiting your spending habits, paying down high-interest debt (and avoiding new debt) and establishing an emergency fund.
Credit counseling could also be an option if you’re looking for guidance on improving your credit and financial situation. Many credit counseling agencies offer some free services, but most charge a fee for creating a debt management plan (DMP).
Summary of our guide on how to get a home equity loan with bad credit
You don’t necessarily need good credit to get a home equity loan, but you will need to meet other lender eligibility requirements. If possible, work on paying down your debt and invest in home improvement projects that can help you build equity in your home and increase the market value of your property. You could also apply with a cosigner with excellent credit to increase your chances of approval.
Remember that applying for a home equity loan with poor credit could mean qualifying for a higher interest rate and a smaller loan amount. Additionally, failure to keep up with loan payments could mean losing your home to foreclosure, so make sure you opt for a home equity product you can afford.
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This story was originally published August 31, 2022 at 6:55 AM.