Home equity loans are different from personal loans because your home serves as collateral when you borrow. But, unlike with a first mortgage, home equity loans are second liens. This means your primary mortgage lender gets first dibs on the home if you default. Since second mortgage lenders can’t collect as easily as primary mortgage lenders because of this, getting a home equity loan with bad credit can be a challenge.
The good news, however, is that there are steps you can take to improve your chances of getting a home equity loan. There are also some lenders willing to provide loan funding to high-risk borrowers, even when their credit score isn’t great. This guide to home equity loans for bad credit will help you understand how you can improve your chances of borrowing while also providing info on some lenders that may be willing to give you a home loan even with imperfect credit.
On this page:
- How to Improve Your Chances of Getting a Home Equity Loan
- Banks That Give Home Equity Loans with Bad Credit
- Repaying Your Home Equity Loan Might Improve Your Bad Credit
- Alternatives to Home Equity Loans
How to Improve Your Chances of Getting a Home Equity Loan
Home equity loan and HELOC requirements are pretty similar for most lenders, as you could potentially borrow the same amount with either loan type.
Typically, for either loan type, lenders evaluate risks associated with giving a would-be borrower a loan against the equity in a collateral property. Lenders have some common factors they’ll look at to assess this risk.
Typically, borrowers need to have stable monthly income for one to two years before applying, as well as a solid credit history. You may be able to get approved at a score as low as 620, but many lenders expect higher before they’ll consider your application.
Borrowers generally also must have at least 15% to 20% equity in the property. That means the loan-to-value ratio including the home equity loan or HELOC needs to be below 85% with most lenders. So, if you start out with an 80% loan-to-value ratio on the primary mortgage, the home equity loan or HELOC can’t generally exceed 5% of the value of your home. If the loan-to-value ratio is only 60% to start, you might be able to get a HELOC or home equity loan for up to 25% of the home’s value. A lower loan-to-value ratio increases the borrower’s probability of approval.
A third requirement is that borrowers need a good debt-to-income ratio, which is the ratio of all of your monthly obligations — including your projected new payment — divided by your monthly income. The higher that ratio, the more likely it is you’ll have trouble making the payment and will default.
Unfortunately, if you have bad credit, this will work against you even if you have a substantial amount of equity in your home. With poor credit, a lender will see you as high risk and may choose to simply deny the loan rather than take the risk that you’ll default.
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, you’ll want to increase it as quickly as possible. While there’s no magic formula for raising your credit score immediately, there are steps you can take to start boosting your score and qualify for a loan at a lower interest rate.
First, check your credit report for any errors. You can get a free credit report from each credit reporting agency every year. As you look over your report, make sure you actually opened all of the accounts listed and check to see if there have been any inquiries 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.
Next, take a hard look at credit card balances and other revolving debt and make a plan to pay off loans as quickly as possible. If you can reduce your credit used down to 30% of credit available to you, this will improve your credit utilization ratio, which should raise your credit score.
Reduce Your Debt-to-Income Ratio
Your debt-to-income ratio is the sum of all of your monthly obligations divided by your gross monthly income. If it’s higher than 35-40%, 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 either increase your income or reduce your debt. You can look at side gigs to make some extra money, cut back on dining out or media streaming services, or even sell things you no longer use. By bringing in a bit more money, you’ll not only increase your income but can also make extra payments on debt, effectively doubling your efforts.
Build Equity in Your Home
You need equity in your home to borrow against it, and there are a few ways you could increase your equity.
Making a larger down payment on a home results in more equity since you put more money in to start out. But, if you’re already in your home, you can’t go back and increase your down payment.
However, you can make your mortgage payments — which also gives you more equity. If you can afford to pay more than your monthly payment amount or can pay on a biweekly schedule instead of making one monthly payment, you can pay down your balance more quickly and build more equity. Unfortunately, many people looking for a home equity loan don’t have a lot of cash to throw at their mortgage.
If it’s been a few years since you had your home appraised, you could also 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 gone up since you last got an appraisal.
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 – and this can significantly increase loan costs. For example, say you’re borrowing $10,000 for 10 years.
- If you have a credit score of 710 and qualify for a loan with a 6% interest rate, monthly payments will be $111.
- If you have a credit score of 620 and qualify for a loan with a 12% interest rate, monthly payments will be $143.
As you can see, bad credit and high interest loans will result in monthly payments – and total costs – being much higher over time than if you had good credit. Since home equity loan interest rates vary by lender, it’s important to shop around for the best interest rate. This is even more essential when you have bad credit because a low credit score tends to cause greater variation in interest rates among lenders.
When you start shopping around, start with your bank where your everyday accounts are. If you already have good history with them, they may be more apt to approve your loan based on that history instead of only looking at your FICO score.
Next, take a look at online lenders. There are several that specifically offer equity loans to people with lower credit scores. Most of them will allow you to check your interest rate without doing a hard credit inquiry that will affect your FICO score.
Banks That Give Home Equity Loans with Bad Credit
In order to find lenders that might give you a guaranteed home equity loan for bad credit, it’s helpful to use an online comparison tool so you can see multiple rate quotes and loan terms in one place. LendingTree is one site where you can compare your mortgage loan options.
LendingTree seeks to match borrowers with lenders looking for home equity loans. When you shop with LendingTree, you just need to fill out a very short application and multiple lenders will give you an interest rate quote.
To complete your application, all you’ll need is your name, date of birth, Social Security number, and the amount you’d like to borrow. LendingTree will do a soft credit inquiry that won’t affect your credit score, and partner lenders will offer details on mortgage rates you could qualify for depending on your type of loan.
Repaying Your Home Equity Loan Might Improve Your Bad Credit
There is some good news for bad credit borrowers. A home equity loan may actually help improve your credit score by diversifying the types of debt on your credit report. And, every month that you make on-time payments you’ll rebuild your payment history and credit score.
Alternatives to Home Equity Loans
You may find yourself in a position where you need cash but simply can’t qualify for a home equity loan. There are still a few options available you can look into.
If you wanted a home equity loan to help your small business grow, Hometap may be able to help. Hometap is more flexible because they make you an investment offer – which is usually 5%-15% of your home’s current value. In ten years you can either sell your home and pay a portion of the proceeds or simply pay the investment back through other means.
This company offers a product called Sell & Stay that lets you sell your home gradually but still live in it as a tenant. You can buy back the home at any time, and if you choose to move out, EasyKnock will put your home on the market and pay you the Sellout Value.
The EasyKnock product is technically called a residential sale-leaseback, and while it does offer access to liquid funds right away, it also means you’ll now be renting the home you owned. Any buybacks will also require a fee of 2.5% of the original sell value.
A home equity line of credit is a bit different than a loan. Instead of receiving a lump sum, you’re given a revolving line of credit based upon your equity. You can borrow up to your line of credit during your draw period and, with most HELOCs, can pay back your loan for up to ten years. During that draw period, you will only make interest payments.
If you don’t need to borrow a large amount up front, getting a smaller HELOC may be a better option. It may be easier to get approved for a smaller line if you have bad credit and you can choose to only use what you need, when you need it. It’s also more flexible than a home equity loan, but you’ll pay slightly higher interest rates.
Personal loans are another option to consider. These are unsecured loans you can get from a variety of lenders, some of whom will lend to borrowers with poor credit. Each lender has its own approval criteria, but you can compare several lenders and find the best one for your situation.
Personal loans typically have higher interest loans than home equity products but you don’t use your home as collateral so aren’t putting your home at risk. Expect to pay anywhere from 8% to more than 100% in interest depending on the amount you borrow, your credit score, and the lender you decide to use.
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, which can save you money on loan costs.
Home Mortgage, Refinance, and Home Equity Loans
- Fixed terms
- Affordable monthly payments
- Cash out up to 90% loan-to-value
Just because you have bad credit doesn’t mean you can’t get the cash you need. Whether you choose to improve your chances of getting an equity loan or choose to go with an alternative, there are plenty of options open to you.