Home equity can be a significant financial asset for you to tap into when life challenges creep up unexpectedly. A great way to capitalize on this is via a home equity loan, secured by the value of your home. It acts as a source of cash for covering emergency expenses, renovations, medical bills, and more.
The main qualification for a home equity loan is having equity (i.e., ownership) in your home. But almost as important is having a good credit score. A poor score below a lender’s average may not necessarily disqualify you from taking out a loan, but it could make it more difficult to land one. You’ll want to be prepared to obtain a home equity loan with bad credit by keeping some considerations in mind.
- A home equity loan is a secured loan borrowed against the value of your home.
- Lenders offering home equity loans customarily are looking for borrowers with credit scores above 700.
- Some lenders will accept loan applications with credit scores in the 600s, although these applicants face much steeper interest rates.
- Prepare to show your financial worthiness in ways such as a low debt-to-income (DTI) ratio, having greater than 20% home equity, and more.
Credit Requirements for Home Equity Loans
The first step in home-equity loan eligibility is straightforward: You need to have at least 20% equity. Home equity is defined as the difference between what you owe on your mortgage and how much you’d get for selling the house.
Twenty percent home equity may seem hard to achieve. The good news is that you probably have more equity in your home than you realize. The down payment you made when purchasing your home starts to build this, along with any mortgage payments you’ve made.
Credit score plays a significant role in whether lenders will approve you for a loan, as a weaker score could signal a risky transaction. Typically, a lender will want to see a score of around 700, but it is possible to find lenders who would work with potential borrowers in the 660 to 700 range.
Lenders weigh other financial factors more significantly when your score is below 700. Having more equity, a lower DTI ratio, and a smaller credit utilization ratio could all tip the scales in your favor.
Typical Rates for Home Equity Loans
A home equity loan is a fixed-rate loan secured by the value of your home. The fixed rate offered can significantly change, depending on your credit score and other factors reviewed by the lender. These include your full credit history, home equity, and lender requirements.
Your unique combination of factors could mean paying thousands of dollars more per year with a lower credit score. For instance, see below typical interest rates at time of publication correlated with scores assigned by credit scoring company FICO, and note how much rates increase based on a low score.
|FICO Score||Typical Interest Rates|
|740 - 850||5.17%|
|720 - 739||5.55%|
|700 - 719||6.8%|
|670 - 699||8.17%|
|640 - 669||9.67%|
|620 - 639||11.17%|
How To Get a Home Equity Loan With Bad Credit
You may still qualify for a home equity loan even with poor credit, although it becomes more difficult below 700. If you decide you need to cash in on your home equity, consider taking a few of the following steps to get into a better financial position. Lenders are likely to reward you with a better interest rate.
Check Your Credit
The Fair Credit Reporting Act gives you the right to receive a free copy of your credit report once every 12 months. Lenders use reports to review where your credit stands when you apply for funding. You’ll want to know the details in the report, check for errors, and be prepared to answer lenders’ questions about it. Order your free, yearly report at AnnualCreditReport.com.
Assess Your Equity
The loan-to-value (LTV) ratio is a way that lenders assess your equity based on how much you owe on your mortgage. On average, LTV needs to be 80% or below, meaning you have at least 20% equity in your home. However, those with lower credit scores may want to showcase higher equity.
Figure out your LTV by using this simple calculation: Current loan balance / current appraised value = LTV.
Look at Your Debt-to-Income Ratio
The DTI ratio represents the total debt payments you make per month as a percentage of your monthly income. Most lenders look for 43% DTI or less for granting a home equity loan, but you should be below that level with a bad credit score. That gives lenders more confidence that you will prioritize loan payments.
Write a Letter Explaining Your Credit Score
Lenders want to know you are trustworthy, and having more equity in your home boosts that confidence. But being prepared to address lenders’ concerns about a low credit score is another solid way to show that motivation. Be proactive in providing a letter to explain your credit history, current score, and actions you’re taking to build credit.
Apply With Multiple Lenders
Shopping around for a loan with multiple lenders is a smart move, regardless of your credit score. Each lender will have different terms and conditions, such as annual percentage rate (APR), possible prepayment penalties, and credit insurance needs. Apply with several lenders you trust and have them compete for your business to get more favorable terms.
Be aware of dishonest lenders in your loan search. Some may create specific terms under which they know you will default. Watch out for lenders who want you to sign blank documents, change set terms, or push you to sign without time for a full review.
Other Loan Options if You Have Bad Credit
You may find that taking out a home equity loan isn’t the best idea with a poor credit score. There are other options to consider based on your financial outlook:
- HELOC: A home equity line of credit (HELOC) acts like a credit card, secured by a home. You can obtain as much money as you need within the draw period. Rates are variable, but you only pay for what you borrow.
- Personal loans: Personal loans are unsecured and can be used for almost any purpose. These tend to come with less-favorable terms, such as higher APRs, based on credit score, so you should still shop around to contend with your weaker score.
- Cash-out refinance: This pays off your first mortgage via a new, larger mortgage with different terms and timelines. The amount of your home equity decreases, although you may find it easier to find a lender that would accept a lower credit score in this scenario.
- Reverse mortgage: A reverse mortgage converts older owners’ home equity into payments from lenders that are, essentially, buying out your ownership.
The Bottom Line
A home equity loan is a good option for a financial boost to cover emergency expenses, starting a business, or doing a home renovation, for example. Having poor credit doesn’t necessarily deny you this opportunity. However, prepare to pay a higher rate, hold more equity in your home, and work harder to convince lenders that you’re a good risk.
If you aren’t happy with the loan options you obtain with your credit score, you may want to pause the endeavor. Instead, take the time to focus on improving your score, and pay special attention to your credit utilization, DTI, and the number of open accounts you have. Paying off debt, contacting creditors for support, and avoiding new purchases all will make you more attractive for a home equity loan.
Frequently Asked Questions (FAQs)
How hard is it to get a home equity loan with bad credit?
It’s not impossible to get a home equity loan with bad credit, but it is more difficult to get approved and to find favorable terms when you have a score below 700. It may save you thousands of dollars to focus on improving your score before taking out such a loan.
What are other home equity loan requirements?
A credit score that meets the lender’s minimum, a maximum LTV of 80%, and a DTI below 43% are standard requirements for a home equity loan. Each lending institution has unique screening standards, and these numbers may look different for someone with a lower credit score.
When can you take out a home equity loan?
You can take out a home equity loan once you review and meet the basic requirements and seek financing. The more equity you have in your house and the higher your credit score, the better your odds to find favorable terms.
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Federal Trade Commission. “Home Equity Loans and Home Equity Lines of Credit.”
Federal Trade Commission. “Fair Credit Reporting Act,” Pages 27-28.
Bank of America. “How To Calculate Home Equity and Loan-to-Value (LTV).”