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Home equity loans require your home to serve 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, 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 information on some bad credit home equity loan lenders.
On this page:
- How to Improve Your Chances of Getting Approved
- How Repayment Could Help Boost Your Score
- Alternative Options to Consider
How to Improve Your Chances of Getting a Home Equity Loan
Home equity loan and HELOC requirements are pretty similar for most lenders.
Typically, 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. These factors may include:
- Monthly income (should be stable for one to two years before applying)
- Credit score (should be at least higher than 620 for most lenders)
- How much equity you have in the property (should have at least 15% to 20% equity in the property)
- A good debt-to-income ratio
If you can’t satisfy the factors listed above, you should consider taking the following steps to improve your chances of approval.
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, you’ll want to 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 start boosting your score to help you qualify for a loan with a lower interest rate.
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 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.
Review Credit Card Balances and Revolving Debt
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 can raise your credit score.
2) 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% 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 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.
3) 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.
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.
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 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.
4) Shop Around
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 10 years.
- If you have a good credit score and qualify for a loan with a 6% interest rate, monthly payments will be $111.
- If you have a bad credit score and qualify for a loan with a 12% interest rate, monthly payments will be $143.
As you can see, high interest loans will result in monthly payments 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 lowest interest rate.
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.
This will help you get approved for other loans down the line, and you should receive a lower interest rate.
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.
Fund your present without risking your future
- Use your home’s equity to do what you want. No debt or monthly payments
- Invest in the future value of your home, giving you access to the money today
- Sell when you’re ready, whether it’s next year or 10 years down the road when the term is up
If you aren’t eligible for a home equity loan but still need financing, Hometap may be able to help. Hometap is more flexible because they make you an investment offer of around 5% to 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.
Use a HELOC
Tap into your home equity to fund your life goals
- Minimum credit score of 640
- 100% online app done from the comfort of your home
- Apply in minutes and close in days
- No need to wait for an in-person appraisal
A home equity line of credit (HELOC) 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 upfront, getting a smaller HELOC from Figure 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.
Use a Personal Loan
Personal loans are another option to consider. These are unsecured loans that 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 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 aren’t putting your home at risk.
Avant is a good option for borrowers with lower credit scores because they offer competitive rates, quick funding, and a variety of repayment terms. You can check your rates with a soft credit pull that won’t affect your credit score before going through the full application process.
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.
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 options open to you.
Author: Jeanette Perez