How to get a home equity loan with bad credit

Having poor credit means you might face a tougher time borrowing money. But it’s not an impossible dream.

There are some major home equity lenders out there that can and do work with borrowers with bad credit. The tradeoff: You’ll likely have to pay a higher interest rate, or have more income or equity in your home to compensate them for the additional risk. However, the higher rate might be worth it if you plan to use the home equity loan to renovate your residence — enhancing its value and strengthening your overall net worth.

How to qualify for a home equity loan with bad credit

Not all home equity lenders have the same borrowing criteria, but the general requirements include:

  • A minimum credit score of 620
  • At least 15 percent to 20 percent equity in your home
  • A maximum DTI ratio of 43 percent, or up to 50 percent in some cases
  • On-time bill payment history
  • Stable employment and income

Lenders that offer home equity loans with bad credit

Yes, there are unscrupulous lenders out there who prey on people with poor credit. But there are plenty of reputable players too.

Home equity lender Loan type Credit score minimum Discover Home equity loans 620 (loans under $150,000) Figure HELOCs 640 (680 for 2nd home) Guaranteed Rate HELOCs 620 Spring EQ Home equity loans and home equity loans 620 (loans)/680 (HELOCs) TD Bank HELOCs and home equity loans 660

How to apply for a bad credit home equity loan

1. Check your credit report

While it’s possible to get a home equity loan with bad credit, it’s still wise to do all you can to improve your score before you apply (more on that below). To start off, check your credit reports to get a sense of where you stand. If there are any errors, like incorrect contact information, contact the credit bureau — the three biggies are Equifax, Experian and TransUnion — to get it updated.

2. Evaluate your DTI ratio

The DTI ratio is a measure lenders use to determine whether you can reasonably afford to take on more debt.

To find out your DTI ratio, simply divide your monthly debt payments by your gross monthly income. For example, say you bring in $6,000 a month in income and have a $2,200 monthly mortgage payment and a $110 monthly student loan payment:

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To make things even easier, you can use Bankrate’s DTI calculator.

For a home equity loan, most lenders look for a DTI ratio of no more than 43 percent. So try to aim for that — or at the very most, stay below 50 percent, the drop-dead cutoff.

3. Make sure you have enough equity

To qualify for a home equity loan, lenders typically require you to have at least an ownership stake of 15 percent or 20 percent. The amount of equity you have, your home’s appraised value and combined loan-to-value (CLTV) ratio help determine how much you can actually borrow.

To calculate your home’s equity, take the current market value of your home and subtract the balance left on your mortgage. For example, let’s say that your home was appraised for $420,000 and you still had $250,000 on your mortgage to pay off.

To calculate your loan-to-value (LTV) ratio, you’ll divide your outstanding mortgage balance by your total loan amount and convert it into a percentage. In this case, you’d have $170,000 in equity and an LTV of 59.5 percent.

Now, say you want to add an $80,000 home equity loan to the mix, and your lender requires you to maintain 20 percent equity (minimum). That’d bring your LTV ratio (now your CLTV ratio) to 78.5 percent — below the 80 percent threshold your lender has limited you to.

You can use Bankrate’s LTV calculator and home equity loan calculator to estimate these ratios, and the amounts you might qualify for.

4. Get a co-signer

If your credit is poor enough that you don’t qualify for a home equity loan on your own, a co-signer might be able to help. On paper, the co-signer is just as responsible for paying the loan back as you are, even if they don’t actually intend to make payments. If you fall behind on repaying the loan, their credit suffers along with yours.

It can be tough to find someone who’s willing to commit to a loan, however, and you’ll still need to qualify for it based on your individual credit. Think of a co-signer as someone who can help strengthen your loan application and increase your chances of approval. Don’t expect it to mean yours gets overlooked.

“A co-signer can help with credit and income issues for an applicant who has a lower credit score, but ultimately the main applicant or primary borrower will have to have at least the bare minimum credit score that is required based on the bank’s underwriting guidelines,” says Ralph DiBugnara, president of Home Qualified, a real estate platform for buyers, sellers and investors.

5. Try a lender you already have a relationship with

If your bank or mortgage lender offers home equity products, it might be more willing to work with you since you’re an existing customer, even if your credit isn’t up to par. For example, if you have a consistent history of making your mortgage payments on time, your lender might take that into consideration.

“A loan officer familiar with the details of an applicant’s situation can help them present it to an underwriter in the best possible way,” says DiBugnara. Still, “the underwriter will decide based on the bank’s guideline and the perceived risk level of the loan. The lower the credit score, the more risk the person will be perceived to be.”

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6. Write a letter to the lender explaining your credit history

You may find more success in getting a home equity loan if you’re upfront about your financial situation. One way to do this is by writing a letter of explanation to lenders, describing why your credit has taken a hit. You’ll also want to attach any relevant paperwork (like bankruptcy documentation) and outline a plan for how you’ll repay this home equity loan.

Simply providing a letter of explanation isn’t a guarantee that you’ll get approved for a loan, however. If you get rejected, you can repeat the process with another lender, but if you’re denied multiple times, you may need to spend some time building your credit before applying again.

Ways to improve your credit

To increase your chances of getting approved for a home equity loan, work on improving your credit score well in advance of applying — at least several months.

Here are three tips to help you improve your credit score:

  • Pay bills on time every month. At the very least, make the minimum payment, but try to pay the balance off completely, if possible. And don’t miss that due date.
  • Don’t close credit cards after you pay them off — either leave them open or charge just enough to have a small, recurring payment every month. That’s because closing a card reduces your credit utilization ratio, which can decrease your score. The recommended utilization ratio: no more than 30 percent.
  • Be cautious with new credit. Getting a higher credit limit on a card or getting a new card can lower your credit utilization ratio — but not if you immediately max things out or blow through the bigger balance. Treat the newly available funds as sacred savings.

How to get a HELOC with bad credit

A HELOC is a revolving credit line, allowing you to borrow against the equity you built in your home (up to 85 percent of your property’s value), at a fluctuating interest rate. You’ll have a draw period, normally 10 years, in which you can borrow money to make home repairs, pay off other debt, or do anything else you like. You only incur interest on the amount you withdraw. Any payments made during this time on the loan can go towards your interest only, with many HELOCs, though you can repay the principal too. After the draw period expires, you’ll no longer be able to borrow funds; instead you’ll have a repayment term of up to 20 years, where you’ll pay interest and principal on the loan.

Applying for a HELOC is pretty much the same as applying for a home equity loan, but if you have bad credit, a loan might have a slight edge over the line of credit. That’s because home equity loans have fixed interest rates and fixed payments, so you’ll know exactly what you need to repay each month. This predictability could help you better manage your budget and keep up with payments. A HELOC, on the other hand, has a variable rate, which can cause unexpected increases in your monthly payments. For this reason, lenders often have higher credit score criteria for HELOCs than home equity loans.

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Home equity loan alternatives if you have bad credit

Here are four more alternatives to a home equity loan:

Personal loans

Personal loans can be somewhat easier to qualify for than a home equity product, and they aren’t tied to your home. This means that if you fail to repay the loan, the lender can’t go after your house. Personal loans have higher interest rates, however, and shorter repayment terms. With bad credit, this translates to a much more expensive monthly payment compared to what you might get with a home equity loan.

Cash-out refinance

In a cash-out refinance, you take out a brand-new mortgage for more than what you owe on your existing mortgage, pay off the existing loan and take the difference in cash. Most lenders require you to maintain at least 20 percent equity in your home in order to cash out. A caveat, however: A cash-out refi only makes sense to do if you can qualify for a lower rate than what you have on your current mortgage, and if you can afford the closing costs. With bad credit, getting that lower rate might not be possible.

Reverse mortgage

Reverse mortgages allow homeowners over the age of 62 to tap into their home’s equity as a source of tax-free income. These types of loans need to be repaid upon your death or when you move out or sell the home. Reverse mortgages can be used for anything from medical expenses to home renovations, but you must meet some requirements to qualify. Most importantly, you’ll need to own your home outright or have paid off most of your mortgage. It might make sense to consider a reverse mortgage over a home equity loan if you want an ongoing source of cash and don’t care about passing your home down to your loved ones after you die.

Shared equity agreement

In a shared equity agreement, you receive a lump sum from an investor or company, that, in turn, receives a percentage of ownership in your home and/or its appreciation. Unlike with HELOCs or home equity loans, you don’t make monthly repayments. Some companies will wait until you sell your home, then collect what they’re owed; others will have multi-year agreements in which you’ll pay the balance in full at the end of a stated period.

Home equity investment companies work with you even if you have a lower credit score, often lower than what traditional lenders would accept. But make sure you understand all the terms of this complex arrangement. Technically, you’re not borrowing money, you’re selling a stake in your home — to a financial professional who naturally wants to see a return on their investment.

FAQ

  • Can I get a HELOC with bad credit?

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  • Can you pull money out of your house with bad credit?

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  • Which has a higher interest rate: a HELOC or home equity loan?

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  • What is a “good” credit score?

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  • Can you get a better interest rate with a higher credit score?

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Additional reporting by Sean Jackson