Can I Get a Home Equity Loan with Bad Credit?

Being a homeowner is not only the way to reach the American Dream. It comes with multiple benefits, and building wealth over time is one of them. Buying a house is more than just a long-term investment. It can also be the key to reaching your current financial goals without even selling your property.

A home equity loan is a great way to improve your financial situation and get advantages from your real estate. But if you have poor credit, you may find it a bit challenging. Let’s explore whether it’s possible to get a home equity loan with bad credit.

Table of Content

• What Is a Home Equity Loan?
• Is It Possible to Get a Home Equity Loan with Poor Credit?
• How Much Can I Borrow with Home Equity Loans?
• Where to Get a Bad Credit Home Equity Loan?
• Alternatives to Home Equity Loans
• How to Improve Your Chances of Getting Approved for a Home Equity Loan?
• Final Thoughts – Is It Possible to Get a Home Equity Loan with Bad Credit?

What Is a Home Equity Loan?

Home equity loans refer to a form of debt that allows you to use your house as a warranty. These loans are also known as second mortgages. They are called so because they represent additional loans taken out on top of your current mortgage. This way, you can take advantage of your house without selling or renting it.

Home equity loans can be used for a variety of purposes. You can finance your home renovation project, make debt consolidation, start your small business, cover tuition fees, or make major purchases. But keep in mind that this loan requires you to pledge your property. Your lender may foreclose on your home if you find yourself unable to make your loan payments as a result of a job loss or other financial troubles.

Is It Possible to Get a Home Equity Loan with Poor Credit?

Although home equity loans are secured debt, most mortgage lenders have their minimum credit score requirements. Lenders pay attention to these factors for a reason. By knowing your credit history, they can determine their chances of receiving loan payments from you on time. A low credit score indicates potential risks for lenders. Thus, it makes it harder for a borrower to qualify for a home equity loan. Also, having a lower credit score can result in higher interest rates.

Some second mortgage providers deal with borrowers whose credit scores are 580 and higher. Others have stricter entry-level criteria and offer their services to applicants whose FICO ratings start from 620 or 640. But if your credit score is lower, don’t lose heart. You can still find a lender that offers subprime loans and has more lenient requirements. But get ready to pay higher interest rates, get less favorable loan terms, and meet stricter income requirements.

How Much Can I Borrow with Home Equity Loans?

The amount you can borrow with a home equity loan is typically based on the amount of equity you have in your home. Equity refers to the portion of home’s value you already own. In other words, it’s the difference between the current market value of your house and the remaining mortgage balance.

For example, if your home costs $600,000, and your outstanding mortgage balance is $350,000, your equity equals $250,000. Most lenders allow customers to borrow 75% to 90% of their available home equity.

Additionally, lenders use a combined loan-to-value ratio (LTV) to determine the maximum amount you can borrow. This ratio is calculated by dividing your outstanding mortgage balance by the current market value of your house. According to the example above, your LTV is 58.3%.

However, keep in mind that the maximum possible loan amount that is based on your available equity is not always the lump sum that you will be able to get. A lender will also pay attention to your income, debt-to-income ratio, and, of course, your credit score.

Where to Get a Bad Credit Home Equity Loan?

Home equity loans are commonly offered by conventional financial institutions. You can find suitable offers from the bank or credit union wherein you’re an existing client or member.

However, you’re not obliged to deal with your current financial service provider only. If its terms don’t meet your demand, search for offers from other traditional lenders in your area.

Also, you can turn to various mortgage brokers or shop around for loan providers that specialize solely in bad credit options.

Alternatives to Home Equity Loans

If a home equity loan seems not the best option for you, here are some more equivalent options to consider.

Home Equity Lines of Credit (HELOCs)

Additionally, home equity lenders can offer certain lines of credit that let you borrow money against the value of your property. Although there are some differences, this option is comparable to a home equity loan. With a home equity line of credit, you can access the funds when needed and within a certain limit. Additionally, you will only pay interest on the amount you use, not the whole loan balance.

Cash-Out Refinance

With a cash-out refinance, you replace your existing mortgage balance with a higher new one. The difference between the old and new mortgage is given to you in cash. You are allowed to use this money to make home improvements or cover other needs without any restriction.

Personal Loans

A personal loan might be a smart choice if you don’t have enough equity in your home or don’t want to use it as collateral. Often, this loan is an unsecured financial product. This means that no collateral is required. But in contrast to second mortgages, personal loans have shorter repayment periods. Thus, your monthly payment amounts can be higher. Also, traditional lenders typically check your credit score and pay attention to it when making loan decisions.

Reverse Mortgages

Homeowners who are 62 or older can turn to a reverse mortgage. This option also allows them to borrow money using the equity in their house. However, the loan is paid back differently. This happens not through regular installments but when the borrower moves out or passes away.

How to Improve Your Chances of Getting Approved for a Home Equity Loan?

A home equity loan can be a great way to access a significant amount without selling your property. However, getting approved for a home equity loan can be a challenge, especially if you have a low credit score or other financial issues. Here are some actions you can take to increase your chances of getting approved.

Explore Your Options

Before you apply for a home equity loan, it’s important to choose the right lender with the best possible offer. Shop around and compare loan proposals from multiple lenders to find the most favorable terms and interest rates. Also, pay attention to closing costs and monthly payments to make sure you will be able to service your debt.

Pay Attention to How Much Equity You Have

To qualify for a second mortgage, you need to have enough equity in your home. Most lenders require you to have at least 15% to 20%, but some may ask for even more equity. To calculate this value, you need to:

1. Subtract your mortgage balance from the current value of your home.
2. Divide the resulting amount by the current value of your home.

Keep Track of Your Debt-to-Income Ratio

Your debt-to-income ratio plays an important role in determining whether you’ll be approved for a home equity loan. You can calculate it by dividing your monthly debt payments by your gross monthly income. Lenders typically prefer a DTI of 43% or less. To reduce your DTI, consider paying off some of your debt, for example, your credit card balances.

Fix Your Credit Report Mistakes

Errors in your credit report can negatively impact your credit score. This will make it harder for you to get approved for a loan. You can make a free credit report check once a year to review it for errors. If there are any, dispute them with the credit bureau. You can also work with a credit repair company to help improve your credit score and meet a lender’s minimum credit score requirement.

Provide a Co-Signer

A co-signer is someone who agrees to take responsibility for repaying the loan along with you. Having a co-signer with good credit can improve your chances of approval and get a better interest rate.

Deal with Your Current Bank or Credit Union

If you’re in a good relationship with your current bank or credit union, it can be a wise solution to apply for a home equity loan from them. They may be more willing to work with existing clients who have a history of responsible banking and a good track record of making on-schedule payments.

Final Thoughts – Is It Possible to Get a Home Equity Loan with Bad Credit?

Getting a home equity loan with bad credit is possible but with several conditions. This is not a guaranteed option. Your credit score is one of the factors that determine your loan cost. This way, a bad credit home equity loan will always be a high-interest debt. Also, borrowers with low credit scores should be ready to meet stricter monthly gross income requirements.

There are several tips on improving your chances of getting a home equity loan. For example, you can reduce your DTI by paying off your existing debt, applying with a co-signer, and more. Also, keep in mind that your options are not limited to home equity loans. You can consider various alternatives that are available with a bad credit score.

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