How to get a home equity loan with bad credit
Published on Bankrate.com Written by Dori Zinn
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
Home equity lender Loan type Credit score minimum
Home equity loans (under $150,000) 620
HELOCs (primary residence) 640
Home equity loans (under 95 percent combined loan-to-value ratio) 620
HELOCs and home equity loans 660
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 more equity in your home to compensate for the additional risk. However, the higher rate might be worth it if you plan to use the home equity loan to further your financial wellbeing, such as adding value to your home by renovating.
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). 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. For a home equity loan, most lenders look for a DTI ratio of no more than 43 percent.
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:
$2,310 / $6,000 x 100 = 38.5 percent
To make things even easier, you can use Bankrate’s DTI calculator.
Although lenders want your DTI ratio to stay below 43 percent, if you have bad credit, the lower the ratio, the better.
3. Make sure you have enough equity
To qualify for a home equity loan, lenders typically require you to have at least 15 percent or 20 percent equity. Your equity level 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, if your home were to appraise for $420,000 and you still had $250,000 on your mortgage to pay off, you’d have $170,000 in equity and a loan-to-value (LTV) ratio of 59.5 percent.
Say you want to add a home equity loan in the amount of $80,000 to the mix, and your lender requires you to preserve at least 20 percent equity. 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 your CLTV ratio and what 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, rather than someone whose good credit means 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.
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 despite your credit.
“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, adding that, 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.”
Ways to improve your credit
To increase your chances of getting approved for a home equity loan, work on improving your credit well in advance of applying. Here are three tips:
• Pay bills on time every month. At the very least, make the minimum payment, but try to pay the balance off completely, if possible.
• 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.
• Don’t max out or open new credit cards. Maxing out your cards or opening new cards raises your credit utilization ratio.
Home equity loan alternatives if you have bad credit
There are three main alternatives to a home equity loan:
Home equity lines of credit (HELOCs)
Home equity lines of credit (HELOCs) apply the same concept as home equity loans: You can borrow a certain amount of funds based on the equity you have in your home. HELOCs are a revolving line rather than a fixed-sum loan, which gives you much more flexibility. They can be a good option for ongoing expenses, such as a long-term remodeling project. They have variable interest rates, however, which means your rate can go up or down. This makes them tougher to budget for.
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.
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