How to get a home equity loan with bad credit
Written by Dori Zinn
Jan. 14, 2022
To get a home equity loan with bad credit, you’ll likely have to have a low debt-to-income ratio (DTI), a high income and at least 15 percent equity in your home. Having poor credit means you might face a tougher time borrowing money, but it’s not impossible to qualify.
In fact, a home equity loan may be easier to qualify for than something like a personal loan if you have bad credit. That’s because a home equity loan is a secured loan; it uses your house as collateral, which offers the bank some “security” in the event that you don’t repay the loan. You’re borrowing against your house and the equity you’ve built up.
Your home equity loan options depend on a number of factors, including just how poor your credit is. Before applying, see what you need to obtain a bad-credit home equity loan.
How do I qualify for a home equity loan if I have bad credit?
Not all lenders have the same standards for home equity loans. Because of this, it is a good idea to shop around and research rates and terms from multiple lenders.
Common home equity requirements include:
- At least 15 percent to 20 percent equity in your home.
- A minimum credit score of 621.
- A maximum DTI of 43 percent, or up to 50 percent in some cases.
- On-time bill payment history.
- Stable employment and income history.
Some lenders may be willing to provide home equity loans to homeowners who have a credit score as low as 620, but it can be especially challenging to find these offers. Discover may work with applicants who have credit scores in this range.
It may also help to look for lenders who do not specify minimum credit score requirements as part of their home equity loan application process. Lenders in this category include Flagstar Bank, Third Federal Savings & Loan, Citizens Bank, Fifth Third Bank, KeyBank, Rockland Trust Bank and Truist (formerly BB&T).
How to apply for a bad-credit home equity loan
Even if you don’t have good or excellent credit, there are still home equity loans available. Here’s what you need to do before you apply for a home equity loan.
1. Check your credit report
Review what the lenders will see by checking your credit report before they do. Typically, you can see yours for free once a year from each of the three major credit bureaus at AnnualCreditReport.com. However, due to COVID-19, you can check it weekly until April 20, 2022. This gives you the chance to remove any errors or work to boost your credit before applying for a home equity loan.
2. Evaluate your debt-to-income ratio
Before you figure out how much you can take out, see how much you can afford by calculating your DTI.
Your DTI divides your monthly debt obligations by your monthly gross income. To calculate your DTI, add up all of your monthly debt, including loans, credit card payments and any other financial obligations. Then, divide this by your monthly gross income. For example, if your monthly debt is $2,000 and your monthly gross income is $5,000, your calculation would look like this:
$2,000 / $5,000 = 40 percent DTI
To make things easy, you can also use a DTI calculator.
A higher DTI is a turnoff to lenders because it means that you have less money to put toward other expenses, such as a home equity loan. Even if you’re making payments, there’s a chance that you could experience a financial hardship that would make it difficult — or even impossible — to repay your home equity loan.
You’ll want to keep your DTI as low as you can, but ideally, it should be less than 43 percent.
3. Make sure you have enough equity
Lenders typically require that you have at least 15 percent or 20 percent equity in your home, and the more equity you have, the better rates you’ll see. Your equity is determined by your loan-to-value ratio, or LTV. The LTV ratio is calculated as a percentage by dividing your remaining loan balance by the home’s current value.
For example, an appraiser might determine that your home is worth $400,000. If you still owe $250,000 on the loan, your LTV is 62.5 percent ($250,000 / $400,000 = 0.625). This means that you have 37.5 percent equity in your home — likely enough to qualify for a home equity loan.
4. Consider how much you need
When borrowing money, it’s easy to take out more than you need just in case something unexpected comes up. Most lenders allow you to borrow up to 80 percent or 85 percent of your home’s value (minus existing mortgage obligations), though some lenders may go higher.
Using the example above, you would make the following calculations to find out how much you can borrow:
- $400,000 (the home’s value) x 0.85 (the maximum percentage you can borrow) = $340,000 (the maximum amount of equity available for borrowing)
- $340,000 (the maximum amount of equity available for borrowing) – $250,000 (the remaining mortgage balance) = $90,000 (the total amount you can borrow from a home equity loan)
Remember that just because you’re eligible to take on a $90,000 loan doesn’t mean you should.
It’s best to borrow only what you need; borrowing in excess will only increase your monthly payments and the total amount of interest you’ll pay.
5. Compare interest rates
Your interest rate depends on many factors, but one of the biggest is your credit score. The lower your credit score, the higher your interest rate.
For instance, a borrower with a credit score between 620 and 639 would pay an average interest rate of 10.88 percent for a 15-year fixed home equity loan of $50,000. That’s more than double the interest rate of a borrower with a top-tier credit rating, according to FICO data. Someone with a poor credit score will pay almost $200 more each month for the same size loan. See the chart below.
Interest rates and payments for a 15-year, $50,000 home equity loan
|FICO SCORE RANGE||INTEREST RATE||MONTHLY PAYMENT|
Source: myFICO.com as of January 14, 2022
6. Use a co-signer
If your credit is poor enough that you don’t qualify for a loan on your own, applying with a co-signer may help. A co-signer applies for your home equity loan with you. On paper, they are just as responsible for paying the loan back as you are, even if they don’t intend to make payments. This means that if you fall behind on repaying your loan, their credit suffers along with yours.
“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.
It is important to be mindful of applying for a loan with a co-signer. Have rules and expectations in place in case you can’t afford to make payments, and be open with your co-signer if something comes up. If you have a history of falling behind on loan payments or you’re unable to pay on time, reconsider using a co-signer.
7. Consider boosting your credit first
To increase your chances of getting approved, work on improving your credit and reducing your debt relative to your income.
- Check your credit report to see if there are any errors, such as lines of credit you didn’t open or other issues, such as overdue payments.
- Pay bills on time every month. At the very least, make the minimum payment, but try to pay the balance off completely.
- Don’t close credit cards after you pay them off. Either leave them alone or have a small, recurring payment every month. Closing cards reduces your credit utilization ratio and can cause your credit score to dip.
- Don’t max out or open new credit cards. Maxing your cards out gives you a high credit utilization ratio, making you look like an irresponsible credit user.
- Pay down existing credit card debt to stay below the recommended 30 percent utilization rate.
Fixing your credit won’t happen overnight. It takes discipline and time. But the rewards — boosting your creditworthiness and gaining financial freedom — are worth it.
8. Try a lender you already have a relationship with
Reaching out to a lender you already have a relationship with is another potential avenue to obtaining a home equity loan if you have poor credit.
As an existing customer, a lender may be more willing to work with you and consider factors beyond just your credit score as part of the application process. For instance, if you have a mortgage with a lender and have a consistent history of making monthly payments on time, that may help you qualify for a home equity loan.
“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. “But ultimately the underwriter will make their decision based on the bank’s guideline and the perceived risk level of the loan. The lower the credit score the more of a risk the person will be perceived to be.”
Can I get a home equity line of credit (HELOC) with bad credit?
You’ll probably face a tougher time borrowing money with bad credit, but getting approved for a HELOC is possible. Because of your lower credit score, however, you might have to pay more in interest.
What is a HELOC?
A HELOC is a line of credit that operates similar to a credit card. As with a home equity loan, your home is the collateral that secures the loan. This loan product lets you borrow money on an as-needed basis. At the beginning of the loan, there’s a draw period that typically lasts for 10 years. During this draw period, you’re responsible for making interest-only payments.
However, once the draw period ends, you’re required to begin making payments toward the interest and principal portion of the remaining balance. Also, if you sell your home during the loan’s term, you’ll have to pay off the remaining balance in full.
Unlike home equity loans, HELOCs typically have variable interest rates. To secure the best interest rate, you need to have a good to excellent credit score, a good debt-to-income ratio and a healthy income.
Risks of HELOCs with bad credit
When you take out a HELOC while having bad credit, one of the most important risks is that you probably won’t secure the best interest rate. This can make using this option more expensive. In addition, it’s harder to budget for repaying your loan since the interest rate varies. If the interest rate increases, it can increase your borrowing costs even more.
Another risk would be drawing too much money before the draw period expires. Although you’re only responsible for making interest payments during the draw period, keep in mind that you’ll have to pay the principal back in the future. Don’t draw more than you can afford to repay.
Finally, the most important risk of taking out a HELOC with bad credit is losing your home if you can’t afford to repay the loan. Since the loan is secured by your home, the lender can foreclose on your home if you’re unable to repay your debt.
Home equity loan alternatives if you have bad credit
Having bad credit might mean not qualifying for a home equity loan, but you have other options to consider as well.
Just as lender requirements vary for home equity loans, the same applies to personal loans. A bad credit score may get you denied, but some lenders have options for low-score borrowers. You just have to look for them.
Personal loans usually have shorter repayment terms, typically up to five or seven years. This means that your monthly payments could be higher than with a home equity loan. Some lenders allow loans up to $100,000, which is comparable to a home equity loan, but many lenders cap their amounts at half of that or less. This could impact which lender you choose.
Because personal loans are unsecured, you’ll need a good credit score or a co-signer to qualify. There are personal loans available if you have bad credit, but your interest rate will be much higher than that of a home equity loan. For example, if you have very poor or fair credit — a credit score that ranges from 300 to 669 — your estimated APR could be between 17.8 percent and 32 percent.
With a cash-out refinance, you pay off your existing mortgage with a new, larger loan, and you receive the difference in cash. Many lenders require you to have at least 20 percent equity in your home for a cash-out refinance.
Unless you can get an equal or lower interest rate, a cash-out refinance might not be the best move. You’ll pay more in interest over the life of the loan, which could be 15 to 30 years. Don’t forget that refinancing a mortgage comes with lender fees and closing costs, too.
The bottom line
Getting a home equity loan with bad credit may be difficult, but it’s not impossible. For the best chance at approval, work on improving your credit score, paying off existing debt and making as many mortgage payments as you can to increase your total equity. From there, shop around with a few lenders to see which will offer you the best interest rate.