In the second quarter of 2022, a total of 48.1% of residential properties with mortgages were considered equity rich, meaning their loan balances were 50% or less than the property’s estimated market value. This creates a unique opportunity for homeowners to tap into their home equity and use the money for other purposes.
However, your credit history can impact your ability to access these funds. While the current average FICO® score is 716, as of April 2021, 15.5% of people had credit scores below 600, putting them into the “poor” or “fair” score categories. If you’re dealing with credit issues, you may wonder whether you can access a home equity loan with bad credit — and in short, you can, though it will take some extra steps. Learn how your credit history affects your ability to get a home equity loan and how to access the funds you need.
How Your Credit History Affects Your Home Equity Loan
When lenders delve into your credit history, they are looking for reassurance that you are likely to repay your loan and make your payments on time. Your credit score is a three-digit number that reflects the scoring company’s assessment of your risk profile. This includes factors such as your current total amount of unpaid debt, your history of making payments on time, and how much credit you’re using overall.
FICO® scores range from 300 to 850. Generally, a score below 670 is considered a “bad” credit score. Those who fall into this range may have trouble qualifying for a loan and may receive less-than-optimal loan terms and interest rates. However, the good news is you may be able to take some steps to improve your risk profile and increase your credit score, leading to better loan access and opportunities.
Improve Your Risk Profile to Get a Home Equity Loan With Bad Credit
If you have a poor credit history, taking some steps to improve your risk profile can increase your chances of being approved for a home equity loan. Here are a few important things to consider.
Reduce Your Debt-to-Income Ratio
Your debt-to-income (DTI) ratio is a measurement of the percentage of your income that is tied up in debt payments. This helps lenders assess your ability to repay your loan and evaluate whether you’re likely to default.
Your DTI ratio is calculated by dividing your monthly debt obligations by your gross monthly income. If your ratio is on the high end, you may try refinancing your outstanding debt. If you’re able to get a lower interest rate or lengthen your repayment period, this can result in a lower monthly payment, which decreases your DTI ratio. You may also consider taking on a side job, which can decrease the DTI ratio by increasing your monthly income.
Build Your Home Equity
Your home equity is calculated by subtracting your total outstanding home loans from the total market value of the property. This may increase over time with no additional effort on your part. However, if you want to increase your equity faster, you may consider making larger monthly payments, making an additional lump-sum payment, or making your payments more frequently. You could also complete renovations, additions, or other improvements to your home to help increase your home’s value.
Commit To Improving Your Credit Score
If your credit score is lower than you would like it to be, there are steps you can take to raise it. Start by checking your credit report. Federal law allows all individuals to get a free copy of their report from each of the three major credit reporting agencies once per year. Once you have a copy of your report, check it for overdue payments and errors, such as evidence of accounts that you did not open. If you find an error in your report, notify the reporting agency right away.
Late payments can have a major impact on your credit score, so focus on paying at least the minimum payment on all of your bills on time every month. Your credit utilization rate is also an important factor. This is the amount of credit available to you versus the amount you’re currently using. Generally, if your utilization rate is above 30%, this can negatively impact your credit score. You can lower this rate by paying down your existing balances, avoiding maxing out your credit cards, and keeping cards open even after you pay them off.
Get a Cosigner
A cosigner is someone who agrees to be responsible for your loan if you fail to pay it back. This is sometimes helpful when trying to get a home equity loan with bad credit since the lender is able to consider the cosigner’s income and credit history as well as yours. Keep in mind that the loan shows up on the cosigner’s credit report too, so if you make late payments or default, it can negatively impact them.
Common cosigner options include parents, spouses, family members, or friends. Lenders typically do not have relationship requirements for cosigners, so it is a matter of finding someone who is willing to take on the risk of consigning for you.
Apply For a Home Equity Loan
When you’re ready, applying for a home equity loan is fairly straightforward, falling into four basic steps:
1. Consult the Requirements For a Home Equity Loan
When applying for a home equity loan with bad credit, it’s important to understand what the lender is looking for. Each lender may have different requirements, and some are stricter than others. In general, lenders typically want to see a credit score that is at least in the fair range (620 or higher) and require borrowers to have at least 20% equity in their home.
The lender may also want to see that your combined loan-to-value (CTV) ratio is within an acceptable range, which is usually 80% or less. To calculate your CTV, start with the total amount of loans secured by your home — for example, your first and second mortgage. Divide this amount by your home’s appraised value. This will give you your CTV.
Finally, your lender may require a debt-to-income (DTI) ratio of 43% or less. However, some lenders accept a DTI ratio of up to 45%.
In addition to checking this information, lenders typically require you to provide documentation to verify your income, employment, and assets. This may include your tax returns, bank statements, pay stubs, and other items so have this information accessible when you apply.
2. Calculate How Much You Should Borrow
Lenders base your maximum home equity loan amount on a percentage of the equity you have in your home. To calculate this, start with the market value of your home and subtract from it the amount you currently owe. For example, if your home is worth $450,000 and your mortgage balance is $200,000, you have $250,000 of equity in your home. The lender may allow you to borrow up to 80% of this amount. In this case, your maximum home equity loan would be $200,000.
However, it’s also important to consider how much you can feasibly pay back. If you’re looking for an equity loan with bad credit, you do not want to take on more debt than you can afford. Not only can missing payments further lower your credit score, but if you default, you could risk losing your home to foreclosure. Instead of accepting the maximum amount you qualify for, consider calculating the amount you actually need and requesting a lower maximum. This may help ensure you do not inadvertently end up with an unmanageable debt payment.
3. Get Ready For a Home Appraisal
Since your home’s appraised value impacts your home equity loan maximum, it’s important to do what you can to make sure it comes in as high as possible. As you get ready for your appraisal, make sure you dress up your curb appeal by mowing your lawn, raking the leaves, clearing sidewalks, and trimming overgrown bushes. Declutter and deep clean your home and make minor repairs. Before the inspector comes, make sure your electricity, water, utilities, HVAC system, and garage doors are all working. Also, check your home’s foundation, roof, and garage for signs of damage and repair anything you can.
If you’ve made home improvements, such as adding a new HVAC system, putting on a new roof, or upgrading your kitchen, it may also be helpful to write this down for the appraiser. If you can, provide documentation, such as invoices or receipts. This may help the appraiser see the extra value you’ve added to your property.
4. Apply For a Home Equity Loan
When you’re ready to apply for your home equity loan, it may be helpful to start by looking for lenders that specifically offer home equity loans for bad credit. Once you’ve found a few possible lenders, compare their loan requirements, interest rates, loan terms, fees, and reputation. This information can help you narrow down your options and make your selection.
Some lenders allow you to complete the loan application online, while others may require you to visit a branch in person for further discussion. After submitting your application, be sure to stay in contact with your lender and quickly provide any requested information. This can help keep the process moving forward and may improve your approval odds.
What to Do If You Are Denied a Home Equity Loan
After reviewing your application and documentation, the lender may determine that you do not meet their qualification requirements and deny your loan application. The next steps depend on the reason for your denial.
In some cases, you may be able to get approved by going to a different lender. It may be helpful to look for lenders that cater to borrowers with credit issues or search for a lender that offers a home equity loan with no credit check option. Just keep in mind that if you choose this option, you may end up paying a higher interest rate and/or additional fees.
On the other hand, if you do not necessarily need to access your home equity right away, the best approach is to work on fixing the reason for the denial. For example, if your credit score is too low, you can take steps to raise it and then reapply once your score has improved. Likewise, if your DTI is too high, you could focus on paying down your current debts. Or if the denial reason is that you do not have enough equity in your home, you can work on paying down your mortgage, making home improvements, or waiting for your home to appreciate. Fixing the reason — or multiple reasons — for your loan denial could allow you to receive optimal loan terms and interest rates once you reapply later.
Other Options to Consider
If you have bad credit, there’s a chance that you may not be eligible for a home equity loan in general. However, there are other options that may help you get the cash you need.
Home Equity Loans vs. Cash-out Refinancing
A cash-out refinance involves refinancing your current mortgage by taking out an amount that is higher than the amount you currently owe. You would immediately use the new mortgage to pay off the old mortgage and take out the difference in cash, which you can then use for any purpose.
This might be an attractive option if you’re able to get a new mortgage with a lower interest rate, as this could save you money over the long term. You may also extend your repayment term, which could lower your monthly payment. However, it’s important to note that refinancing your mortgage typically involves additional lender fees and closing costs, so ensure that these costs do not cancel out your potential savings.
Home Equity Loans vs. Personal Loans
Depending on how much money you need, a personal loan may also be an alternative option to a home equity loan. These loans typically have repayment periods in the 5 to 7-year range. Keep in mind that while some lenders offer large personal loans that may be comparable to what you could get with a home equity loan, many cap them at much lower amounts.
Since personal loans are unsecured, you may still have difficulty qualifying with a bad credit score. However, there are some lenders that specifically cater to borrowers with poor credit. Having a cosigner could help your chances of approval as well.
It’s important to note that when taking out a personal loan with a poor credit score, you could end up paying much higher interest rates. When considering this option, be sure to compare lenders and read the fine print to make sure you understand the loan terms and all of the costs involved.