Home Equity Loan With Bad Credit: Is It Possible?

Article Summary:

A home equity loan is a type of debt that allows homeowners to borrow against the equity of their homes. To apply for a home equity loan with bad credit, it’s useful to check your credit report, calculate your debt-to-income ratio and the amount of equity you have, determine how much you need, and shop around for the best rates. To help boost your chance of getting a home equity loan with bad credit, stay aware of your credit score, calculate your monthly DTI, and consider bringing on a cosigner. Personal loans, cash-out refinance options, and shared equity agreements are alternatives to taking out home equity loans.

Equity is one of the greatest benefits to owning a home. The more equity you can build, the more you’re able to borrow against that equity to finance your big plans. You might be able to pay for your children’s college education, renovate a part of your house in need of repair, or handle unexpected life expenses with a home equity loan.

While it’s important to always maintain a good credit score, sometimes that’s not always realistic. If you find your credit score isn’t what it could be, you can still apply for a home equity loan. Before applying for a loan, however, it’s important you stay aware of your credit report, determine how much money you’ll need, and shop around for the best interest rates. You don’t want your credit to worsen due to your home equity loan.

What is a home equity loan?

A home equity loan is a type of debt that allows homeowners to borrow against the equity of their homes. The amount of the home equity loan is based on the difference between the home’s current market value and the homeowner’s mortgage balance due.

Home equity loans typically have fixed interest rates. They come in two varieties: fixed rate loans and variable rate loans. Home equity lines of credit (HELOCs) are a similar product that provides a line of credit, like a credit card, instead of a lump sum. If you fail to make the monthly payment on your home equity loan (or your HELOC), you risk losing your home to foreclosure.

What type of credit score do you need for a home equity loan?

Ideally, you should have a good credit score when applying for a home equity loan. This means a credit score of at least 620, though some lenders want to see a minimum score closer to 680. The better your credit score is, the lower your interest rates will be, and the greater chance you’ll have to get approved for a home equity loan.

How can I qualify for a home equity loan with bad credit?

Most mortgage lenders have different standards when it comes to home equity loans. The most common home equity loan requirements include:

  • A credit score of at least 620, though 700 or higher is ideal.
  • At least 15% to 20% equity on your home.
  • A debt-to-income (DTI) ratio of 43% or less. This means that no more than 43% of your income would go toward your debt payments.
  • On-time bill payment history, as well as stable employment and income.

If you can’t meet the minimum credit standard required to obtain a home equity loan, your lender will look for you to make it up through other criteria. For example, this could mean having more than 20% equity on your home.

Pro Tip

It might be helpful to look for lenders that do not specify minimum credit score requirements, as these might be more willing to work with you on other criteria.

How do I apply for a home equity loan with bad credit?

To apply for a home equity loan with bad credit, there are certain steps you need to take to ensure you apply with the lender most suited to you. You also want the loan that will bring you the most value.

Check your credit report

You can obtain one free credit report per year from any of the three major credit bureaus. Check your credit report for any errors or erroneous charges, and for evidence of identity theft or fraud. These might bring down your credit score and should be disputed immediately.

Calculate your debt-to-income ratio

Lenders will also consider your DTI when making a decision on your home equity loan application. Your DTI indicates how much of your gross monthly income goes toward paying off debts.

To calculate your DTI, add all of your monthly debt and divide this number by your monthly gross income. A higher DTI is unattractive to lenders because it means you have less money to put toward other expenses, such as your monthly payments on your home equity loan.

DTI = total monthly debts / monthly gross income

Calculate the amount of equity you have

Most lenders require you to have at least 15% to 20% equity on your home. If you have a greater amount of equity, you’ll be more attractive to lenders.

You can calculate the amount of equity you have by determining your loan-to-value ratio (LTV). To find this, divide your remaining loan balance by your home’s current value.

LTV = remaining loan balance / your home’s current value

Determine how much you need

When trying to get a home equity loan, you don’t want to take out more than you can pay. While most lenders allow you to borrow up to 85% of your home’s value, some allow you to borrow more.

Borrowing money in excessive amounts can increase your monthly payments and raise the total amount of interest you’ll have to pay.

Shop for the best rates

One of the biggest determining factors when it comes to interest rates is your credit score. The better credit score you have, the lower your interest rate will be. If you have bad credit, this can greatly impact the amount of interest you’re paying.

Pro Tip

Try getting interest rate quotes from at least three to five lenders before making your final choice. Do a line-by-line comparison, as fees and closing costs can vary.

How much equity can I borrow from my home?

Most lenders will let you borrow 80% to 85% of your home’s appraised value. However, in order to borrow this amount, you must have a loan-to-value ratio no higher than 80% to 85%. This amount is equal to 15% to 20% equity on your home.

What is a home equity line of credit?

A HELOC operates similarly to a credit card and typically has variable interest rates. A HELOC lets you borrow money on an as-needed basis. Like with a home equity loan, your home serves as the collateral that helps you obtain a HELOC.

At the start of the HELOC, there’s a 10-year draw period, during which time you’re responsible for making interest-only payments. Once the draw period is over, you’re required to make payments toward the principal and interest. If you sell your house during the term of the loan, you must pay off any remaining balance in full.

Can you get a HELOC with high debt-to-income ratio?

Although lenders have different requirements concerning DTIs, you will likely need to stay under your lender’s maximum DTI to qualify for a HELOC. The Consumer Financial Protection Bureau recommends keeping your DTI under 43%, a guideline many lenders follow.

How hard is it to get a HELOC?

As long as you meet certain parameters and guidelines put in place by lenders, it shouldn’t be too difficult to get a HELOC. For example, if you keep your DTI under 43%, most lenders will qualify you for a HELOC.

There are some risks associated with HELOCs, however. For example, when you take out a HELOC with bad credit, you risk being unable to secure the best interest rate. Also, if you draw too much money before the draw period expires, you risk losing control of your interest payments and taking out more than you can afford to repay.

How can I help my chances of getting a home equity loan with bad credit?

Getting a home equity loan with bad credit might be more difficult than it would be if you met the minimum credit score requirements, but it’s not impossible.

Check your credit score

One of the most important things you can do before applying for a home equity loan is to check your credit scores. While lenders have different minimum credit score requirements, the majority of lenders look for a credit score of at least 620, though 700 or higher is ideal.

Most lenders will want to see your FICO credit score, which can require a payment depending on your credit card company. You can also obtain one free credit report per year from any of the three major credit bureaus.

Calculate your monthly debt-to-income ratio

Your DTI ratio is another important factor lenders look at when you apply for a home equity loan, especially if you have bad credit. This measures how much of your monthly gross income is used to pay your debt obligations.

Most lenders look for a DTI of 43% or less. However, if you have a bad credit score, you’ll need a lower DTI to qualify for a home equity loan.

Get a cosigner

Getting a cosigner can help increase your chances of getting a home equity loan with bad credit. A cosigner can be a family member, close friend, or anyone with good credit who can vouch for you as a borrower. They also agree to repay the loan if you cannot.

Having a cosigner can be a riskier option. If you miss your loan payments, your cosigner’s credit can suffer alongside yours. Also, if you don’t make your payments, your cosigner becomes legally responsible for making them.

What are alternatives to home equity loans if you have bad credit?

If you are unable to qualify for a home equity loan due to your bad credit, there are other options available that can still get you the money you need.

Personal loans

Personal loans have shorter repayment periods than home equity loans, usually ranging from five to seven years. However, this means that your monthly payments with a personal loan could be higher than if you had a home equity loan.

While there are some personal loans you can get if you have bad credit, interest rates will be much higher than a home equity loan. Personal loans typically require good credit, or at least a cosigner in order to qualify.

Cash-out refinance

With a cash-out refinance, you can pay off your existing mortgage with a new and larger loan, then pay the difference in cash. Most lenders require you have at least 20% equity in your home to qualify for a cash-out refinance.

However, a cash-out refinance means you’ll have to pay greater interest over the life of the loan. This period could be anywhere from 15 to 30 years, which can tie you down considerably.

Shared equity agreements

Shared equity agreements allow homeowners to cash out their home equity without getting into debt. Also known as home equity investments, they give homeowners a lump sum in exchange for a share in the future value of their homes. When the homes are sold or when the contract term ends, the investors receive their share of the investment from the sale.

A shared equity agreement isn’t technically a loan, as it won’t increase your debt, doesn’t involve interest rates, and is free of monthly payments. They can be good options if you have a lot of debt to pay off or need to finance a home renovation project.

However, shared equity agreements do require a substantial amount of equity, upwards of 25% or more. So they may not be the best option if you are looking to stay in your home for longer than the terms of the agreement.

Key takeaways

  • A home equity loan is a type of debt that allows homeowners to borrow against the equity of their homes. The amount of the home equity loan is based on the difference between the home’s current market value and the homeowner’s mortgage balance due.
  • The most common home equity loan requirements include: a credit score of at least 620, though 700 or higher is ideal; at least 15% to 20% equity on your home; a DTI ratio of 43% or less; and an on-time bill payment history, as well as stable employment and income.
  • To apply for a home equity loan with bad credit, check your credit report, calculate your DTI, calculate the amount of equity you have, determine how much you need, and shop around for the best rates.
  • A home equity line of credit, or HELOC, lets you borrow money on an as-needed basis. Like with a home equity loan, your home serves as the collateral that helps you obtain a HELOC.
  • To help boost your chance of getting a home equity loan with bad credit, stay aware of your credit score, calculate your monthly DTI, and consider bringing on a cosigner.
  • Personal loans, cash-out refinance options, and shared equity agreements are alternatives to taking out home equity loans.
View Article Sources
  1. Home Equity Loan vs. Line of Credit: Which Should You Choose? – SuperMoney
  2. Reverse Mortgage vs. Home Equity Loan vs. HELOC: Pros & Cons – SuperMoney
  3. Best Shared Equity Alternatives – SuperMoney
  4. A Personal Loan With A Cosigner? It Can Lower Your Rates and More – SuperMoney
  5. Home Equity Loans and Home Equity Lines of Credit – Federal Trade Commission
  6. What is a second mortgage loan or “junior-lien”? – Consumer Financial Protection Bureau