Your home equity represents a reliable source of financing should you need to unlock cash relatively quickly, but your borrowing power goes hand in hand with your credit score. Most lenders require a solid score because they want some reassurance of your creditworthiness before blindly doling out money. A strong credit history demonstrates that you’ll likely make good on your payments and, in turn, be a worthwhile borrower.
But what happens if your credit score leaves something to be desired? Getting approved for a home equity loan or home equity line of credit (HELOC) becomes more challenging with poor credit — but that’s not to say it’s impossible.
Here’s the lowdown on shopping for a home equity loan with bad credit.
What are home equity loans and how do they work?
Let’s back up and unpack what home equity loans and HELOCs even are. While each is structured a little differently, both are secured types of debt that use your home as collateral. That means if you default on your payments, you could wind up losing your home. (Not a fun thought, but definitely worth your attention when considering the pros and cons.)
When lenders consider you for a loan or line of credit, the amount of equity you have in your home is as important as your credit score. Most lenders require a loan-to-value (LTV) ratio of less than 90% after factoring in the new loan. Let’s say your home is valued at $225,000 and you currently have $100,000 left on your mortgage. That means you have $125,000 in equity. You can figure out your LTV by dividing what you owe by the home value. In this example, your LTV would be 44%.
Once approved for a home equity loan, you’ll receive a lump-sum of money — typically limited to 85% of your equity — with a fixed interest rate. HELOCs, on the other hand, work more like a variable-rate credit card. Your borrowing power is the same, but instead of receiving a lump sum, you borrow as you go and make interest-only payments along the way. You can borrow during the draw period, which generally lasts for about 10 years. After that, you’ll begin paying back the principal balance as well.
Why would you want a home equity loan?
If you qualify, a home equity loan or HELOC can be an affordable and quick source of financing, and there are no restrictions around what you can use the money for. Whether you’re faced with a stretch of unemployment, a medical emergency, a home renovation or college costs, your home equity may be the vehicle that gets you over the hump. You can also use a home equity loan to consolidate high-interest debt and ultimately save money on interest.
Of course, there are some downsides to consider as well. You may be on the hook for some closing costs, depending on the lender. Closing costs are typically 2% to 5% of the loan value. HELOCs also come with variable interest rates, which means they go up and down over the life of the loan. If it takes you awhile to pay off the balance, you may end up paying a lot in interest over the long haul. And again, if your budget can’t keep up with the monthly payments and you end up defaulting, you could lose your house.
What’s considered bad credit, anyhow?
Now that we’ve gotten the basics down, let’s talk approval — more specifically, credit requirements. This begins with understanding what FICO considers a good credit score.
According to Tendayi Kapfidze, chief economist for LendingTree, which owns Student Loan Hero, the best rates and terms are usually reserved for borrowers with the strongest credit.
“The average home equity borrower definitely has a score well above 700,” he told Student Loan Hero.
Have a score that’s under that mark? Don’t fret; approval may still be possible since lenders also consider things like your equity, employment and income when making a lending decision. But getting approved with bad credit, according to FICO, will ultimately cost you more. Here are the national average APRs for HELOCs and 10-year home equity loans based on credit score, as of January 9, 2019.
|Credit Score||HELOC||10-Year Home Equity Loan|
How can you get a home equity loan with bad credit?
There are no hard-and-fast rules here. While one lender may require one credit score, another might be willing to work with you if you meet their other qualifying criteria.
“Shopping around online gets you exposed to more lenders,” said Kapfidze. “Given that you’re trying to find a lender that’s willing to work with your situation, the more lenders you consider, the better your chances.”
Connect with lenders and compare quotes to clarify your options. Credit unions or smaller community banks may be more open to working with borrowers who don’t have perfect credit. Kapfidze says your best chance is to try a financial institution where you already have an established relationship. Maybe you already have an auto loan with a nearby credit union and have been a stellar borrower. Your positive history with them may be convincing enough that they’ll overlook your credit score.
Another option is bringing on a cosigner with strong credit who’s willing to assume responsibility should you fail to repay the loan. They’ll have no ownership rights, which might make it harder to find someone willing to sign on, but it’s an option nonetheless that could tip the scales in your favor.
One other note regarding equity: Owning a good chunk of your home could be the make-or-break detail that gets you approved for a home equity loan with bad credit.
“If you have 100% equity in your home, for example, you’ll probably find somebody who’s willing to give you a home equity loan even with pretty poor credit,” said Kapfidze. “But as your available equity decreases, your options also decrease.”
No matter which lenders you’re communicating with, drive home the fact that you’ve got a plan in place to improve your credit.
What steps can you take to improve your credit?
Assuming you have sufficient equity, improving your credit is the best way to up your odds of being approved for a home equity loan or home equity line of credit. The downside is that this won’t happen overnight. (If you’re in a bind where you need cash fast, a personal loan may be a better option.)
“If you have time, time heals everything,” said Kapfidze. “You can take measures to improve your credit score and improve your overall debt profile, and maybe your equity in your home will also be increasing.”
Your payment history represents 35% of your FICO score, so be sure to stay on top of your payments. Late payments stay on your credit report for seven years. And as you continue reducing your open balances, your debt-to-income ratio will also go down. This does not affect your credit score, since the amount you owe on a mortgage doesn’t go into your FICO score, but lenders do seriously consider your debt-to-income ratio.
If it feels like you never have enough to make more than your minimum payments, consider revamping your budget and reducing your expenses to funnel more money toward your debt. Side gigs are another way to up your income and reduce your debt burden faster. Just avoid closing out any credit card accounts along the way, as doing so can actually hurt your credit score.
Another healthy financial habit is to check your credit report for errors. You can dispute these with the three major credit reporting agencies (Experian, Equifax and TransUnion), and have them taken off your report, boosting your score in the process. You can access each of your three reports at no charge once a year via AnnualCreditReport.com.
Some parting thoughts
Getting approved for a home equity loan or HELOC with bad credit can be tough, but it is possible — assuming you have adequate home equity, a steady job and a reliable source of income. You may get pinned with a higher interest rate, but it still may be your best option if you’re stuck between a rock and a hard place.
The ideal situation would be to delay the loan process to give yourself time to repair your credit and improve your chances of getting approved. At that point, you’ll likely qualify for a lower rate and better terms.