Home Equity Loans and Bad Credit

A home equity loan allows you to leverage the equity you’ve built up in your home to use as collateral in a loan. Unlike a home equity line of credit, with a home equity loan you’ll get the entire amount up front with a fixed rate term and payment. But what are your home equity loan options if you think you have bad credit? Let’s start by breaking down how credit is built to help you understand why you may have been told that you have bad credit.

What is a Credit Score?

A credit score is a number that is generated based on your credit behaviors. It predicts the likelihood of paying your creditors back on time. Your credit behaviors are things like your history of paying your bills on time, and how much money you owe. One of the most commonly used types of credit scores is FICO®, which we explain more about on our FICO Score page.

What Does it Mean if I’m Told I Have Bad Credit?

It can be discouraging to be told you have bad credit, especially if you are looking to apply for a home equity loan or line of credit. But everyone’s situation is different, so being told you have bad credit can mean several things. Here are some general points:

• Typically, bad credit means you might have had issues with paying creditors back on time. Usually loan payments, credit card payments, car payments, mortgage payments, and/or medical bills that are more than 30 days past due is considered late and gets reported as such on your credit report.
• It’s possible that any debt that was turned over to a credit collection agency for non-payment can hurt your credit.
• Having little or no credit history can make it hard to be approved for your first loan because credit is built over time. This doesn’t mean you have bad credit – just that you don’t have enough credit history. Check out this resource from Experian on steps to take to build your credit.

If you find yourself in a situation where you have what’s considered to be bad credit, meet with a banker. We’re here to help you understand what exactly that means, and we’d love to walk through your financial situation to make a plan for helping you to rebuild your credit.

Is it Possible to Fix Bad Credit?

Speaking of rebuilding credit, it sure is possible. Credit behaviors are reported to credit bureaus each month, so they have the potential to go up or down each month. There’s no magic cure or quick fix for bad credit, and the most important thing to do is build a budget so you can pay bills on time, every time.

A few more tips for rebuilding credit:

• If possible, pay down extra beyond minimum payments on high balances that you owe, especially credit cards. Check out this calculator too for determining how long it will take you to pay off your credit card.
• If possible, put money away to save for an emergency so that you don’t have to take on new debt the next time your car breaks down and needs to be fixed. Using a savings calculator can be a great start.
• Positive behaviors like paying debt on time and paying down high balances will improve your credit over time.

Here are additional resources from the Federal Trade Commission:

Coping with Debt

Getting Out of Debt

Settling Credit Card Debt

Credit Repair: How to Help Yourself

Can I Qualify for a Home Equity Loan if I Have Bad Credit?

Here’s what a lender will look for when you apply for a home equity loan or a home equity line of credit.

Credit History – like we talked about above, we’ll review your credit history to help determine your ability to repay the loan. We want to make sure that the home equity loan you are borrowing won’t be a significant burden on your financial life, and that you’ll be able to repay the loan with as few challenges as possible.

Equity You Have in Your Home – this is a key difference between applying for a home equity loan with bad credit and applying for a personal loan. Because the equity you’ve built up in your house will be used as collateral for your loan, the amount of equity determines who much you’ll qualify to borrow. As a rule of thumb, a typical amount to borrow is 85% of the value of your home for a home equity line of credit and 80% for a home equity loan, after subtracting the amount you owe on your mortgage. For personal loans, your house will not be used as collateral on your loan.

Debt to Income Ratio – this is another way that we make sure that you can repay your home equity loan, even if you struggle with bad credit. Your Debt to Income ratio is the total of all the debt you pay each month, including items like your mortgage and credit cards, divided by your gross monthly income.

How Your Credit Score will Impact Your Home Equity Loan

If you qualify for a home equity loan even with a less-than-perfect credit score, keep in mind that your rates could be higher. In general, if you have a lower credit score you are likely to have higher interest rates because you could be considered a high risk borrower. It’s super important to fully understand what your monthly payments will be so you can make sure you can make your home equity loan payments comfortably. Use tools like our “How much can I afford to borrow” calculator to run your numbers.

Learning More

If you’d like to learn more, please contact our Financial Education Coordinator, Anna Frank, at AFrank@fcbanking.com. We also have a page of tips for improving your credit score.