How To Get A Home Equity Loan With Bad Credit

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A home equity loan can be a great way to borrow money at a low cost to fund home improvements or consolidate debt. But if you have bad credit (FICO score below 580), you could have a tough time getting approved.

Getting a home equity loan with bad credit isn’t impossible, though. Here’s how to do it.

4 Tips to Boost Your Chances of Approval

1. Check Your Credit Score

Before you apply for a home equity loan, it’s a good idea to find out where your credit currently stands. Free sites such as Credit Karma provide educational credit scores, which can be helpful for getting a ballpark idea of your current credit score. However, most lenders rely on your FICO credit score, which sometimes requires a payment to see the score—though some credit card companies allow customers to get their FICO scores for free.

Most lenders require a score of at least 680 in order to get approved for a home equity loan. That’s considered a “good” score. However, you may still be able to qualify for a home equity loan with bad credit. Since home equity loans are secured by your property, meaning your home serves as collateral if you default on the loan, there’s less risk to the lender. And it can help if your other financial qualifications are strong.

2. Calculate Your Monthly Debt-to-Income Ratio

Your debt-to-income (DTI) ratio is one of the most important factors that lenders consider when approving you for a mortgage. This number measures how much of your monthly gross income is used to pay your debt obligations, expressed as a percentage. For example, if you earned $6,000 per month before taxes, and you paid $2,100 a month for your student loan, car and credit card payments, your DTI would be 35%.

Lenders prefer to see a DTI of 43% or less, though some may accept up to 50% in some cases. However, if you have bad credit, you’ll need a pretty low DTI to qualify for a home equity loan.

3. Check Your Home Equity

You also need to have sufficient equity built up in your home, especially if you’re attempting to secure a home equity loan with bad credit. Lenders use what’s called a loan-to-value (LTV) ratio that divides your current mortgage balance against your home’s current appraised value. For example, if your home is worth $300,000 and you still owe $240,000 on your mortgage, your LTV is 80% ($240,000/$300,000). That means you have 20% equity in your home.

Typically, lenders require that you have a LTV of 80% or less in order to borrow a home equity loan. To find out how much your home is currently worth, you’ll need to have it appraised, which typically costs a few hundred dollars.

4. Find a Co-signer

Another way to help your chances of securing a bad credit home equity loan is to bring on a co-signer. This means that a trusted family member or friend with good credit essentially vouches for you as a borrower, and agrees to repay your loan if you can’t.

Before going this route, it’s important to understand the risks. If you miss your loan payments, your co-signer’s credit can suffer, along with yours. And if you fail to make your payments, the co-signer becomes legally responsible for the debt. Of course, the hope is that you would never end up in this situation. But if you do, it can damage your relationship along with both of your credit scores.

How to Find Lenders Willing to Work With Bad Credit

If you have bad credit, it can be tough to find lenders that are willing to extend you a loan. It’s important to shop around and get quotes from several lenders, especially since the interest rate will be higher and getting the lowest rate possible will save you a lot of money in the long run. Some places to look include:

Local banks and credit unions. Community banks and credit unions might have more flexibility when it comes to their underwriting standards than big banks do especially if you are already a customer there. They also have to compete harder for business, and may be willing to take on riskier loans.
Online lenders. Since there is little overhead compared to a brick-and-mortar bank, online lenders can transfer those savings to their customers in the form of lower interest rates and fees. Plus, it’s easy to get quotes online without a hard credit inquiry, allowing you to get several offers to compare within a few minutes.

Once Approved, Keep Improving Your Credit

If you’re able to secure a home equity loan despite your bad credit, congratulations. But you shouldn’t stop there. Some day, you might want to take on another loan, refinance your mortgage or open a lucrative rewards card—and having good credit will make that much easier.

You can start by pulling a free copy of your credit reports from each of the major bureaus (Equifax, Experian and TransUnion) at AnnualCreditReport.com and review them for any issues. For example, you might find an error, which can drag down your score. If you do find a mistake, be sure to dispute it with the bureau that’s reporting it, as it can take weeks to fix on your credit report.

It’s also a good idea to look for any negative marks that could be easily fixed, such as a credit card that’s maxed out or a bill that was sent to collections. Taking the time to address these issues will help your score improve more rapidly.

Other Financing Options

If you’re struggling to qualify for a home equity loan with bad credit, you may want to consider other financing options. You have a few alternatives:

Cash-out refinance. Another option is to refinance your current mortgage with a new loan at a larger amount, and pocket the difference. This is similar to a home equity loan, as you still need to have at least 20% equity to qualify and your home serves as the collateral for the loan. However, if you’re able to refinance at a lower rate than what you’re currently paying, it could be a good deal.
Personal loan. If you’d rather not take on a loan that’s secured by your home, consider a personal loan instead. Unsecured personal loans allow you to borrow money without collateral. As a result, however, you’ll pay a higher interest rate, especially with damaged credit. In fact, personal loan rates can be as high as 36%. Securing your loan with an asset, such as a bank account or vehicle, can lower your rate.
Reverse mortgage. If you’re age 62 or older, you may be able to leverage your home equity in the form of a reverse mortgage. Rather than paying back the loan in monthly installments, you receive either a lump-sum, monthly payments or line of credit. The interest is added to your loan balance and doesn’t need to be paid until you move out or die. In most cases, the home is then sold and proceeds are used to pay off the balance.

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