Getting a Home Equity Loan with Bad Credit

A home equity loan can be a powerful financial tool for homeowners, allowing them to tap into the equity built in their property for major expenses like renovations, debt consolidation, or emergency costs. However, securing a home equity loan with bad credit can be challenging, as lenders typically prioritize borrowers with strong credit histories. That said, it’s not impossible. With strategic planning and a clear understanding of the process, you can still access home equity, even with less-than-perfect credit.

Can you get a home equity loan with bad credit?

Yes, it’s possible. A lower credit score doesn’t automatically disqualify you from getting a home equity loan. Some lenders may accept FICO scores in the “fair” range (low 600s), provided you meet other criteria related to debt, home equity, and income.

That being said, it won’t be a simple process. Lenders are often more cautious with home equity loans than with traditional mortgages. However, it’s not out of reach. Here’s how you can obtain a home equity loan, even with bad credit.

Requirements for home equity loans

Home equity lenders may have varying criteria, but there are some common guidelines you’ll generally encounter. Typical requirements for home equity loan applicants include:

• A minimum credit score of 640
• At least 15% to 20% equity in your home
• A debt-to-income (DTI) ratio of no more than 43%, though some lenders may accept up to 50%
• A history of on-time mortgage payments
• Stable employment and income

To find out the specific requirements of a particular lender, you’ll need to conduct research online or reach out to a loan officer directly. If you’re not quite ready to apply, consider requesting a no-credit-check prequalification to prevent a loan inquiry from impacting your credit score.

What are “good” and “bad” scores for home equity loans?

First, let’s clarify the credit score ranges. According to FICO, the most widely used credit scoring model, scores are categorized as follows:

• 300-579: Poor
• 580-669: Fair
• 670-739: Good
• 740-799: Very Good
• 800-850: Excellent

For home equity loans, lenders typically require higher credit scores than for traditional mortgages. This is because home equity loans are considered riskier. If you default and your home is seized, the home equity loan, as a “second lien,” is paid only after the primary mortgage is settled.

Additionally, home equity loans don’t have a robust secondary market like most mortgages, which limits their liquidity. Although Freddie Mac proposed creating a secondary market for these loans in April, this market remains underdeveloped. As a result, lenders bear more risk when originating and holding these loans.

Due to these factors, home equity lenders often impose stricter criteria, usually requiring scores in the “fair” range or higher. A score in the 500s, which might be acceptable for an FHA mortgage, will struggle to qualify for a home equity loan. Some lenders have recently relaxed their standards and may approve scores as low as 620, but many institutions still prefer scores above 700. Requirements can vary even within a single lender, depending on factors like loan amount and terms.

As with any loan, a lower credit score typically means you’ll face higher interest rates.

How to apply for a bad credit home equity loan

When applying for a home equity loan, especially with bad credit, it’s crucial to not only secure financing but also to optimize your chances of getting the best possible rate. Follow these steps to improve your application process:

1. Check your credit report

Begin by checking your credit reports at AnnualCreditReport.com to understand your current credit standing. If you find any errors, such as incorrect personal information, promptly contact the relevant credit bureau—Equifax, Experian, or TransUnion—to have them corrected.

2. Determine your equity level

To qualify for a home equity loan, you typically need to own at least 15% to 20% of your home’s value outright. Your equity, home’s appraised value, and combined loan-to-value (CLTV) ratio will determine the amount you can borrow.

Here’s a simple way to calculate your equity: Subtract your mortgage balance from your home’s current value. Although lenders will use the official appraised value to determine your borrowing limit, you can estimate your home’s value using resources like Bankrate or real estate portals.

For example, if your home is valued at $420,000 and you owe $250,000 on your mortgage:

$420,000 – $250,000 = $170,000

However, you can’t necessarily borrow the full $170,000. If the lender requires you to maintain at least 20% equity, you need to retain $84,000 ($420,000 \times 0.20). This leaves you the potential to take out a home equity loan of up to $86,000 ($170,000 – $84,000).

Note: Ensure that your combined loan-to-value (CLTV) ratio, which includes all your home-related debts, stays within the lender’s limit, often 80% or lower.

3. Find out your DTI ratio

Lenders use your debt-to-income (DTI) ratio to assess whether you can handle additional debt. To calculate your DTI ratio, divide your total monthly debt payments by your gross monthly income. For instance, if you earn $6,000 a month and have a $2,200 mortgage payment plus a $110 student loan payment:

$2,310 / $6,000 x 100 = 38.5%

For a home equity loan, most lenders prefer a DTI ratio of 43% or lower.

4. Consider a co-signer

If securing a home equity loan is challenging due to your credit score, a co-signer with better credit might increase your chances of approval. A co-signer shares the responsibility for repaying the loan and their credit will be affected if you default on payments.

While a co-signer can help with credit and income issues, you will still need to meet the minimum credit score requirements set by the lender. According to Ralph DiBugnara, president of Home Qualified, “A co-signer can assist with credit and income issues for an applicant with a lower credit score, but the primary borrower must still meet the lender’s minimum credit score requirements.”

5. Try a lender you already work with

If your current bank, credit union, or mortgage lender offers home equity loans, consider applying with them. As an existing customer, you may benefit from some flexibility or additional assistance with your application.

“A loan officer who knows your financial history can present your case to the underwriter more effectively,” notes DiBugnara.

6. Write a letter to the lender

Draft a letter of explanation addressing why your credit score is low, particularly if there have been recent setbacks. Be factual and straightforward, including any relevant documentation such as bankruptcy records. If your credit issues were due to temporary circumstances like job loss, but you are now employed, explaining this context can help the lender better understand your situation.

Lenders that offer home equity loans with bad credit

Several home equity lenders are willing to work with borrowers who have lower credit scores. Here are a few options to consider, along with their specific requirements:

Lender	Loan types	Credit score minimum	Maximum CLTV	Maximum DTI
Figure	HELOC	640	75%-90%	Undisclosed
Rate	HELOC	620	90%-95%	50%
Spring EQ	Home equity loan, HELOC	620 for home equity loans, 680 for HELOCs	Up to 90%	43%
TD Bank	Home equity loan, HELOC	660	Undisclosed	Undisclosed
Connexus Credit Union	Home equity loan, HELOC	640	90%	Undisclosed
Discover	Home equity loan	660	90%	43%

Pros and Cons

Securing a home equity loan with bad credit offers both advantages and risks. While it can provide you with needed funds, it also comes with potential drawbacks.

Pros

• Access to Funds: A home equity loan provides a substantial amount of cash that can be used for home improvements, consolidating high-interest debt, or handling major expenses.
• Fixed Rate: Home equity loans come with a fixed interest rate, allowing you to know exactly how much you’ll pay each month. This predictability can help you budget effectively and manage your debt, potentially improving your credit score.
• Debt Consolidation: If you have high-interest debt, such as credit card debt, you might use a home equity loan to pay it off at a lower rate, consolidating your payments into one lower monthly installment.

Cons

• Increased Debt Load: Taking on additional debt may not be advisable if you’ve struggled with money management in the past, even if you qualify for the loan.
• Higher Costs: A lower credit score may result in higher interest rates, making the loan more expensive over time.
• Risk of Foreclosure: Missing loan payments can harm your credit score further and, in the worst case, lead to foreclosure if you are unable to repay the loan.

What to do if your home equity loan application is denied

If your home equity loan application is turned down, don’t lose hope. Start by asking the lender for specific reasons for the denial. Understanding these reasons can help you address any issues and improve your chances for future applications.

If credit was a factor, you can enhance your score by making timely payments and reducing outstanding debt. If insufficient home equity was the issue, work on building more equity—primarily by continuing to pay down your mortgage—before reapplying.

These improvements may take six months to a year to significantly impact your credit profile. If you need a quicker solution, consider applying with different lenders as their criteria might be more flexible. Keep in mind that more lenient terms might come with higher interest rates or fees.

Home equity loan alternatives if you have bad credit

If you need funds but have poor credit, a home equity loan is just one option. Here are some alternatives:

Personal loans

Personal loans are often easier to qualify for than home equity loans and don’t involve your home. However, they typically come with higher interest rates and shorter repayment terms, leading to higher monthly payments.

Cash-out refinance

With a cash-out refinance, you obtain a new mortgage larger than your current loan, pay off the old loan, and take the difference in cash. Most lenders require at least 20% equity in your home for this option. It’s beneficial if you can secure a lower interest rate than your existing mortgage, but with bad credit, this may be challenging.

Reverse mortgage

Available to homeowners aged 62 and older, a reverse mortgage allows you to convert home equity into tax-free income. This loan must be repaid upon death, sale of the home, or when you move out. It can be used for various expenses, but you must meet specific eligibility requirements.

Shared equity agreement

Home equity investment companies may offer shared equity agreements even if your credit is low. These agreements involve receiving a lump sum in exchange for a share in your home’s ownership or its appreciation. Unlike traditional home equity loans or HELOCs, you don’t make monthly payments. Instead, some companies collect their share when you sell the home, while others require payment at the end of a set period.

How to get a HELOC with bad credit

Applying for a Home Equity Line of Credit (HELOC) is similar to applying for a home equity loan, but if you have bad credit, a home equity loan might offer some advantages. Home equity loans feature fixed interest rates and consistent monthly payments, making it easier to manage your budget and keep up with payments. This predictability can be beneficial if you’re worried about fluctuating payments.

In contrast, a HELOC typically comes with a variable interest rate, which can lead to unexpected increases in your monthly payments. Because of this, lenders often set stricter credit score requirements for HELOCs compared to home equity loans.

Tips for improving your credit before getting a home equity loan

To boost your chances of approval for a home equity loan, focus on improving your credit score several months before you apply. Here are three key strategies:

• Pay Bills on Time: Ensure that you make all bill payments on time each month. Aim to pay off the full balance when possible, but at a minimum, make the minimum payment by the due date.
• Keep Credit Cards Open: After paying off a credit card, avoid closing the account. Keep it open or make small, recurring charges to maintain a good credit utilization ratio (CUR). A CUR of no more than 30% is ideal. Closing a card can negatively impact your CUR and lower your credit score.
• Be Cautious with New Credit: While obtaining a higher credit limit or opening a new credit card can help reduce your CUR, avoid maxing out the new credit or quickly spending the increased balance. Treat any additional credit as a reserve, rather than an opportunity to increase spending.