Having poor credit means you face a tougher time borrowing money, including when it comes to qualifying for a home equity loan.
A home equity loan is a secured loan with your house serving as collateral, which offers the bank some “security” in the event that you don’t pay it back. You’re borrowing against your house and the equity you’ve built up.
Getting a home equity loan with bad credit is possible, but your 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, you should shop around for rates and terms from multiple lenders. Banks will be more likely to approve you for a home equity loan if you have at least 15 percent equity in your home, stable employment and income, fair credit and a debt-to-income ratio of no more than 43 percent.
Home equity requirements include:
- At least 15 percent to 20 percent equity in your home.
- A minimum credit score of 620.
- A maximum debt-to-income ratio (DTI) of 43 percent, or up to 50 percent in some cases.
- On-time bill payment history.
- Stable employment and income history.
If your credit isn’t great, lenders may require that you carry less debt relative to your income and have more equity in your home.
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
See what the lenders will see by checking your credit report before they do. You can see yours for free once a year at AnnualCreditReport.com. 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, you should first see how much you can afford by calculating your debt-to-income ratio.
Your debt-to-income ratio, or DTI, divides your monthly debt by your monthly gross income. To calculate your DTI, add up all of your monthly debt, including all of your loans, credit card payments and any other financial obligations. Then divide this by your monthly income. For example, if your monthly debt is $2,000 and your monthly 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, like 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 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 or 85 percent of your home’s equity, 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)
$350,000 (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 10.78 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||
|740 – 850||
|720 – 739||
|700 – 719||
|670 – 699||
|640 – 669||
|620 – 639||
Source: myFICO.com as of June 9, 2020
6. Use a co-signer
If your credit is poor enough that you don’t qualify for a loan on your own, you may need to get a co-signer to help.
A co-signer applies for your home equity loan with you. On paper, they’re just as responsible for paying back the loan as the primary applicant, even if they don’t intend to make payments. This means that if you fall behind on repaying your loan, their credit will suffer along with yours.
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, like lines of credit you didn’t open or other issues, like overdue payments.
- Pay bills on time every month. At the very least, make the minimum payment, but try your best to pay off the balance 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 and can cause your credit score to dip.
- Don’t max out or open new credit cards. Maxing out your cards gives you a high credit utilization rate, 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.
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, usually 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.
With a cash-out refinance, you pay off your existing mortgage with a new, larger loan, and you receive the difference in cash. Like other home equity products, 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.
Featured image by alexmisu of Shutterstock.