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To get a home equity loan with bad credit, you’ll need more income, more home equity and less total debt than someone with good credit. You’ll also pay a higher rate than you would if you had better credit, but it may be worth it to pay off high-interest debt or make some home improvements to boost your home’s value.
How to qualify for a home equity loan with bad credit
The qualifying requirements for a home equity loan are stricter because it’s considered a “second mortgage,” which means it’s paid after your first mortgage if you default and the lender forecloses on your home.
If you’re getting a home equity loan with bad credit, lenders will need to:
- Verify you have at least 15% equity in your home. Home equity lenders typically lend up to a maximum of 85% of your home’s value, according to the Federal Trade Commission. Equity is the difference between the home’s market value and your current mortgage balance.
- Cap your loan amount at a set combined loan-to-value ratio. A loan-to-value (LTV) ratio measures how much your total loan amount is compared to your home’s value, and is expressed as a percentage. The balance of your current loan plus your new home equity loan balance can’t exceed the LTV ratio limits set by the lender.
- Review your credit scores and payment history. Most home equity lenders require at least a 620 credit score, but some lenders set minimums as high as 660 or 680. They will also verify which types of accounts you use, how much you owe, how long the accounts have been open and, most importantly, if you’ve paid the accounts on time.
- Check your debt-to-income ratio. You’ll need to prove you earn enough to cover your current monthly bills plus the new home equity loan payment. Usually the percentage of your gross monthly income used to repay debt, known as your debt-to-income (DTI) ratio, can’t be more than 43%. However, lenders may set even lower requirements for borrowers with bad credit.
6 steps to apply for a home equity loan with bad credit
The process for applying for a home equity loan with bad credit is similar to getting any other type of mortgage, but there are a few extra steps you’ll need to follow.
1. Gather information about your current mortgage
Home equity lenders will need a copy of your most current monthly mortgage statement to make a final home equity loan offer.
2. Check your home’s value
If you’re not sure, ask the real estate agent that helped you buy your home to prepare a comparable market analysis. However, the lender will usually order an appraisal to confirm the value, so don’t count your home equity money just yet.
3. Try a home equity loan calculator before you apply
Once you know your home’s value and your current mortgage balance, try a home equity loan calculator to start your home equity loan search. The calculator does the math for you and gives you a rough idea of whether the full application is worth the effort. Lenders calculate your maximum home equity loan amount by multiplying your home’s value by the max LTV ratio they allow and then subtracting your outstanding mortgage balance to determine your maximum home equity loan amount.
4. Write letters of explanation for your bad credit in advance
If you’ve had some tough financial times, write a letter to explain what happened and how you’ll be able to repay the home equity loan. Be prepared to provide documentation, such as bankruptcy papers, divorce decrees or anything else related to your financial situation to accompany the explanation letter.
5. Apply with three to five home equity lenders
You may need to shop around more to get a home equity loan with bad credit, as not all lenders offer them. An online home equity loan comparison tool saves you time by allowing you to enter your information and get calls from lenders who compete for bad credit home equity loans.
6. Provide your documents and close your home equity loan
Once your home equity loan is approved, the process is similar to getting a regular mortgage. The lender verifies all the information from your application and once it’s finalized, you’re ready for closing. After you sign your paperwork, you’ll receive the funds from your home equity loan at the end of your right to cancel period, which lasts for three business days.
Pros and cons of a home equity loan with bad credit
Interest may be tax-deductible if used for home improvements
Interest rates are lower than personal loan interest rates
Funds are disbursed quickly and can be used for any purpose
Fixed-rate payments stay the same for the life of the loan
Interest rates and the monthly payment will be higher than if you had good credit
Lenders could foreclose and you could lose your home if you default
You may be limited to a lower maximum loan amount
Interest is not tax-deductible if it’s used for debt consolidation
What if I want to get a home equity line of credit with bad credit?
Another popular second mortgage option for tapping your home’s equity is a home equity line of credit (HELOC). A HELOC works like a credit card for a set time called a “draw period,” during which you can borrow from your credit line. After that time, the balance must be paid off in installments.
Common features of HELOCs include:
- Up to a 10-year draw period when you charge and pay off the balance as needed
- The option for interest-only payments during the draw period
- Variable rates for the life of the loan
- Annual maintenance fees, membership fees and termination or early-close out fees
- Terms of five to 20 years
Pros and cons of a home equity loan vs. a HELOC
The interest-only option temporarily keeps the payment lower than a home equity loan
Flexibility to charge and pay off the balance as needed during the draw period
Payments are only based on the amount used
Adjustable mortgage rate could result in a higher payment if rates rise
Ongoing maintenance, membership, termination or close-out fees may apply
The payment could become unaffordable after the draw period ends and the balance is due
Alternatives to home equity loans with bad credit
If you’re not quite sure that a home equity loan meets your financial needs, consider these other home equity-tapping options.
Conventional or government-backed loan programs allow you to replace your existing mortgage with a larger loan amount and pocket the difference with a cash-out refinance. If current mortgage rates are low or your credit scores are below minimum standards for a home equity loan, a cash-out refi program may be a good alternative.
A cash-out refinance typically comes with:
- Lower interest rates compared to a HEL or HELOC
- Higher closing costs because you’re taking out a larger loan
- The ability to get approved for up to 80% of your home’s value with credit scores as low as 500 for loans insured by the Federal Housing Administration (FHA)
- DTI ratio limits up to 50% for conventional and FHA loans
- Longer terms up to 30 years
- A cash-out limit of up to 90% of your home’s value if you’re a military borrower eligible for a loan backed by the U.S. Department of Veterans Affairs (VA)
If you’re age 62 or older, you may be eligible for a reverse mortgage to convert equity into income without making a monthly payment. The catch: Your loan grows over time instead of shrinking because the monthly interest is added to your loan balance.
Features of a reverse mortgage include:
- More options to receive your equity than a HEL, including monthly payments, line of credit or a lump sum
- No minimum credit score requirement for the home equity conversion mortgage (HECM)*
- proof you aren’t delinquent on any federal debt and can pay ongoing property taxes, homeowners insurance and maintenance costs
- Higher closing costs than a home equity loan with origination fees up to $6,000
- Losing home equity over time because your loan balance grows instead of shrinks
*Although there is no credit score minimum, lenders will require proof you aren’t delinquent on any federal debt and can pay ongoing property taxes, homeowners insurance and maintenance costs
A personal loan is unsecured and typically comes with higher rates and a shorter repayment term — and because it’s not secured by your home, there’s no risk of losing your home if you default on a personal loan.