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When taking out a home equity loan, your property will serve as collateral on the debt. Unlike a first mortgage, home equity loans are second liens. If you default, your primary mortgage lender gets first dibs on the home.
Since second mortgage lenders can’t collect on defaulted debts as easily, getting a home equity loan with bad credit can be challenging.
You can improve your odds of getting approved for a home equity loan, even when your credit score isn’t great. This guide to home equity loans for bad credit will help you understand how to improve your chances of borrowing and where to find banks that give home equity loans to borrowers with bad credit.
In this guide:
- Can you get a home equity loan with bad credit?
- Where to get home equity loans with bad credit
- How to improve your chances of approval
- How bad credit impacts the cost of borrowing
- How to apply for a home equity loan or HELOC with bad credit
- Repaying your home equity loan might improve your bad credit
- Risks of getting a home equity loan with bad credit
- Alternatives to home equity loans
Can you get a home equity loan with bad credit?
The requirements for a home equity loan and HELOC (home equity line of credit) are similar for most lenders.
Lenders typically start by evaluating would-be borrowers for risk: if they approve a loan against the equity in a borrower’s collateral property, how likely is that borrower to pay the debt back as agreed?
Lenders have common factors they’ll look at to assess this risk. These factors may include:
- Monthly income should be stable for one to two years before applying.
- Credit score should be at least 620 for most lenders.
- How much equity you have in the property, at least 15% to 20% equity is ideal
- A good debt-to-income ratio is how much you owe compared to how much you make; many lenders won’t want this number to exceed 35 to 45%.
As mentioned, a home equity loan is a second lien, so if you were to default on your loan, your primary mortgage lender would get the property first. If there’s not enough money recovered, your second lienholder might not get repaid.
Home equity lenders may have stricter credit score requirements to lower their risk. While this doesn’t make it impossible to get a home equity loan with bad credit, it can make it more difficult. Your approval will hinge on how well you meet the lender’s other requirements.
Where to get home equity loans with bad credit
While not every lender will approve a bad credit borrower, some banks offer home equity loans to borrowers with limited or bad credit. These loans have higher interest rates and may be stricter on other income or total equity requirements.
Here are some of the top lenders to consider for home equity loans with bad credit.
Bank of America
Bank of America offers financial products and services in all 50 states, including home equity lines of credit. They have flexible qualifying requirements for their HELOCs, which can make it easier to get approved even if you have bad credit.
There are no application fees or closing costs. They also offer rate discounts for auto-pay enrollment and to existing Bank of America customers.
|Credit score requirements||Not specified|
|Loan amount||Maximum CLTV of 80% to 85%, with a maximum loan amount of $1,000,000|
|Starting interest rate||6.65% variable APR|
|Repayment terms||10-year draw period on HELOCs|
Flagstar Bank offers personal banking solutions, loans, and investment services. They have flexible HELOC and home equity loans, though availability varies by location. Flagstar has no specified minimum credit score requirement, so approval may be possible for borrowers with bad credit who meet other eligibility thresholds.
|Credit score requirements||Not specified|
|Loan amount||Maximum CLTV of 80% with a maximum loan amount of $1,000,000|
|Starting interest rate||6.25% variable APR|
|Repayment terms||10-year draw period on HELOCs|
How to improve your chances of approval
If you’re a homeowner with bad credit and are hoping to take out a home equity loan, there are some things you can do to improve your chances of approval. Regardless of your credit rating, it may be a good idea to focus on the following steps before applying for a home equity loan.
That’s because your credit score can significantly impact the interest rate you’re offered. This can affect the total cost of your loan and potentially save or cost you more money.
Here are the best ways to improve your chances of loan approval if you have bad credit to ensure that your loan has the most competitive terms possible.
1. Work on improving your credit score
While some lenders will approve your application with a credit score as low as 620, typically lenders want to see a higher score. And, if you’re approved with a low score, you’ll pay higher interest rates and have a higher monthly payment.
If your score is below 620, increase it as quickly as possible. While there’s no magic formula for immediately raising your credit score, there are steps you can take to boost your score to help you qualify for a loan with a lower interest rate.
2. Check your credit report for errors
You can get a free credit report from each credit reporting agency every year. As you look over your report, make sure all the accounts listed are correct and check to see if any inquiries have been made in your name that you don’t recognize.
Accounts you didn’t open, and inquiries you didn’t make could suggest identity theft. You’ll also want to ensure any accounts you’ve paid off aren’t showing an outstanding balance.
3. Review credit card balances and revolving debt
Take a hard look at credit card balances and other revolving debt and plan to pay off loans as quickly as possible. Reducing your used credit down to 30% of the credit available to you will improve your credit utilization ratio, which can raise your credit score.
4. Reduce your debt-to-income ratio
Your debt-to-income ratio is the sum of all your monthly obligations divided by your gross monthly income. If it’s higher than 35% to 40%, it can be a sign you’re living above your means and may be at risk of defaulting on your loans.
To lower your debt-to-income ratio, you’ll need to increase your income or reduce your debt. You can take on side gigs to make extra money, cut back on dining out or media streaming services, or even sell things you no longer use.
By bringing in more money, you’ll not only increase your income but can also make extra debt payments, effectively doubling your efforts.
5. Build equity in your home
You need equity in your home to borrow against it, and there are a few ways you could increase it.
If you can afford to pay more than your monthly payment amount on your mortgage or can pay on a biweekly schedule, you can pay down your balance more quickly and build more equity.
If it’s been a few years since your home was appraised, you could have that done again. If the value comes back as $350,000, but the last appraisal was $300,000, you just gained $50,000 in equity. This is only recommended if home values have increased since you last got an appraisal.
6. Consider getting a cosigner
A cosigner is an individual who also agrees to secure your new loan. This cosigner shares the obligation to repay your debt and can be held responsible if you default on the loan.
Your cosigner’s credit history and income will be considered when you apply for your home equity loan. If they are creditworthy, adding them could be the key to getting your application approved.
Remember that the loan balance and payment history will also be reported to your cosigner’s credit. If you make late payments or default entirely, they will see their credit affected and be held liable for any remaining debt.
How bad credit impacts the cost of borrowing
Since the loan interest rate is a measure of loan risk, borrowers with bad credit should expect to pay more than the advertised home equity rate. This can significantly increase loan costs. For example, say you’re borrowing $10,000 for ten years.
- If you have a good credit score and qualify for a loan with a 6% interest rate, monthly payments will be $111. The total interest paid is $3,322.
- If you have a bad credit score and qualify for a loan with a 12% interest rate, monthly payments will be $143. The total interest paid is $7,217.
As you can see, high-interest loans will result in higher monthly payments and more interest paid than if you had good credit. Since home equity loan interest rates vary by lender, shop for the lowest interest rate.
How to apply for a home equity loan or HELOC with bad credit
If you’re a homeowner with bad credit and want to take out a home equity loan or HELOC, here are the steps you should take to apply. You may notice that this process is similar to applying for other types of mortgages.
Determine how much you can borrow
The amount you can borrow with a home equity loan or HELOC is limited to a portion of the equity that you have in your home. To calculate this, determine your home value, then subtract your mortgage loan balance.
So, if your home is worth $400,000 and you owe your lender $110,000, you have $290,000 in equity. This is your LTV, or loan-to-value ratio. However, you can’t borrow the entirety of this equity; instead, lenders mitigate their risk by only allowing you to borrow against a certain percentage.
Combined loan-to-value, or CLTV, is the ratio comparing all liens on your property against its market value. Each lender has its own CLTV limit, but 75% to 80% is common. You could borrow up to $210,000 against your property if your lender’s CLTV limit was 80%.
$400,000 x 0.80 = $320,000 CLTV limit – $110,000 existing mortgage = $210,000
Gather information on your current mortgage
When applying for a home equity loan or line of credit, your potential lender will likely ask for details on your existing mortgage. Gather this documentation beforehand to streamline the process and make your application move along faster.
This might include providing them with your most recent mortgage statement and a current payoff quote.
Make your case with a letter
Consider a proactive approach when applying for a home equity loan as a bad credit borrower. This could mean drafting a letter for potential lenders beforehand, explaining your situation, and giving them some personal insight.
For example, if you have bad credit due to a divorce or serious illness, explain that. You may also want to provide documentation that could serve as further explanation. This could include bankruptcy filing papers, divorce decrees, and more.
Any time you’re looking for a new loan, it’s smart to shop around. This can help ensure that you have the best chance at approval and that you’re likely to snag the best possible rates and loan terms.
Shopping around with multiple lenders will give you some options to choose between. You can then compare rates, fees, repayment terms, and loan limits to decide which offers the most attractive option overall.
Move forward with your application
Once you’ve selected a lender, it’s time to apply. You’ll need to provide the lender with the necessary documentation and information so that they can adequately process your application.
This could mean giving them copies of your recent pay stubs or W-2s, past tax returns, current mortgage statements, bank statements, copies of your identification, and more.
Repaying your home equity loan might improve your bad credit
There is some good news for bad credit borrowers.
A home equity loan may improve your credit score by diversifying the types of debt on your credit report. And, you’ll rebuild your credit score with each on-time payment.
This will help you get approved for other loans down the line, and you should receive a lower interest rate.
Risks of getting a home equity loan with bad credit
The biggest risk is that home equity loans are secured by the value in your home. This means that if you default on your loan’s repayment, you risk the foreclosure of your home. Not only will your credit be impacted further, but you could lose the roof over your head.
Home equity loans involve closing costs, which must be paid at the time of loan origination. You might be able to roll some of these costs into your new loan, though that increases your total cost. In contrast, personal loans and credit cards don’t charge closing costs, so a home equity loan can be more expensive upfront.
And of course, borrowers with bad credit are usually subject to higher interest rates on their loans. This means that you will pay more over the life of your loan than you would if you had a higher credit rating and score.
Alternatives to home equity loans
You may find yourself in a position where you need cash but can’t qualify for a home equity loan. There are still a few options.
You can get unsecured personal loans from various lenders, some of whom will lend to borrowers with poor credit. Each lender has its approval criteria, but you can compare requirements for bad credit loans here to find an option that works for you.
Personal loans typically have higher interest loans than home equity products, but you don’t use your home as collateral, so you aren’t putting your home at risk.
When you take a cash-out refinance, you refinance your first mortgage and borrow more than you currently owe. The difference is taken out as cash to be used for whatever you need. In some cases, you can lower your interest rate too, saving you money on loan costs.
A reverse mortgage provides homeowners over age 62 with a lump sum payout against the equity in their property. The difference is that reverse mortgage borrowers aren’t required to make monthly payments on that loan. Instead, the debt is repaid once the borrower no longer lives in the home.
Interest charges accumulate on the reverse mortgage loan, but you don’t have to worry about paying them monthly. If you have bad credit, this can be a more attractive option as your score won’t result in a higher monthly payment requirement.
That said, reverse mortgages push the cost into the future. You’ll still have to repay the debt if you move or pass your home on to your loved ones.
Author: Stephanie Colestock