How to get a home equity loan with bad credit
If your credit isn’t good, you still can get a home equity loan
A home equity loan allows a homeowner to borrow against their home without affecting their primary mortgage. This type of loan draws from a portion of the home's equity and has equal monthly payments.
Generally, the higher your credit score, the better rate and terms you'll qualify for on a home equity loan. But you can still get one with bad credit. Here’s how.
Key insights
- Homeowners with bad credit can get home equity loans.
- Home equity loans for those with bad credit may have higher interest rates or fees and stricter underwriting criteria.
- Boosting your credit score can increase your approval odds and improve your loan terms.
Can I qualify for a home equity loan with bad credit?
You can qualify for a home equity loan with bad credit if other factors make up for it. For example, you may have substantial income, significant savings or a low loan-to-value (LTV) ratio on your home.
Each lender has different requirements for approving loan applications. However, you typically need:
- At least 15% to 20% equity in your home
- An on-time payment history and stable employment
- A minimum credit score of 620
- A maximum debt-to-income (DTI) ratio of 43% to 50%
How to find a lender for bad credit home equity loans
David Lee, a mortgage loan officer with the lender iQ Mortgage, recommends "talking to multiple lenders to get the best deal on your home equity loan. Some lenders have very strict underwriting guidelines, while others are more flexible and accommodating to people with bad credit."
Here’s how to find a lender that caters to borrowers with bad credit:
- Start at your local bank branch to see if it offers bad-credit home equity loans.
- If it doesn’t, ask if it can refer you to a lender that does.
- Contact a mortgage broker with access to lenders for all credit types.
- Ask friends and family for recommendations.
How to apply for home equity loan with bad credit?
Getting a home equity loan involves several steps. If you have bad credit, taking some extra steps can improve your chances of getting your application approved.
- Check your credit report. Get a free copy of all three of your credit reports from AnnualCreditReport.com. Review them for unknown addresses, fraudulent accounts and other errors.
- Fix any errors you find. If you find any errors on your credit report, ask the credit bureaus to correct them. The quickest way is to submit your dispute online through their websites.
- Boost your credit score. Improve your credit score by paying down revolving accounts like credit cards and lines of credit. Make your payments on time, and avoid applying for any new credit.
- Get an estimate of your home equity. Use websites like Zillow or Redfin to estimate your home's current value. Subtract your existing mortgage balance from that amount to determine how much equity you have.
- Determine how much money you need. Identify how much money you need to borrow. Consider including a buffer in case you underestimate the amount.
- Determine if you have enough equity. Compare how much equity you have to how much you want to borrow. Is there enough equity in your home to meet that request?
- Shop lenders to compare rates and fees. Search for lenders that specialize in lending to homeowners with bad credit. Compare their rates, fees, LTV maximums and other important factors. Also, talk to a bank you have an existing relationship with. It may be more willing to work with you.
- Prepare your documents. Every lender is different, but almost every one requires certain documents. These include paystubs, W-2s, tax returns, mortgage statements, property tax bills and insurance policies.
- Submit your application. Complete the lender's application online, at a branch or over the phone. Have information about your home ready, such as your mortgage payment, insurance premiums, property taxes and HOA dues.
- Find a co-signer (if needed). Depending on your credit score and financial situation, some lenders may require a co-signer on your application. If that's the case, talk to friends and family to determine who is willing to help.
- Get a home appraisal. A home appraisal provides an independent, third-party opinion of your home's value. There are three main types of appraisals: full (inside inspection of the home), drive-by (appraiser stays outside your home) and desktop (using recent sale comps). Your lender determines what type is necessary based on its internal process and the size of your loan request. In some cases, the lender absorbs the cost of the appraisal. The value of your home and the balance on your first mortgage dictates how much the bank lets you borrow against your home. In other words, the higher your home's appraised value, the more money you can get from it.
- Respond quickly to any lender requests. Your lender may have questions while underwriting your loan application. Promptly provide any additional information, supporting documents or updated pay stubs, if necessary.
- Sign the loan documents. Review the loan documents to ensure they match the terms you were quoted.
- Receive the loan proceeds. The lender may issue a cashier's check or wire the money to your bank account. If you're using the loan funds to consolidate debt, the lender may be able to pay your creditors directly.
- Start making payments. Set up automatic loan payments so you don't miss any. Some lenders provide a discount when you do this.
Home equity loan alternatives for bad credit
A home equity loan isn't always the best choice when you have bad credit. You may incur more fees and a higher interest rate than if you had good or excellent credit. You also may need a higher income and lower DTI ratio to get approved.
Other types of financing that might be a better match are:
- Personal loans: These unsecured loans typically have a shorter repayment period, which is ideal when you only need to borrow a small amount.
- Home equity line of credit (HELOC): With a HELOC, you only pay interest on what you withdraw from your line of credit.
- Credit card 0% APR offer: Some credit cards offer a 0% APR introductory period. These offers provide no-interest financing on purchases, balance transfers or both. You usually have 12 to 21 months to repay your balance before the promotional rate expires.
- 401(k) loan: Your employer plan may allow you to borrow against your 401(k) to get the money you need. This doesn’t require a credit check, but you may be penalized if you leave your job before you repay the loan. For instance, if you leave your job with an outstanding 401(k) loan balance, it is considered an early withdrawal. You'll pay taxes on the balance and may be subject to a 10% penalty.
- Cash-out refinance: When you refinance your mortgage, you can withdraw additional cash from your equity. This is a good option when your original mortgage interest rate is equal to or higher than current rates.
FAQ
What is considered bad credit?
Typically, a FICO score below 670 is considered less than good. Scores between 580 and 669 are considered fair, while scores below 580 are poor.
What kind of interest rate can I get on a home equity loan with bad credit?
Interest rates for home equity loans vary based on many factors, including the amount borrowed, LTV ratio and term. The current interest rate environment also affects rates. In mid-January 2023, typical home equity loan rates for borrowers with bad credit ranged from 7.49% to 13.99%.
What’s the difference between a home equity loan and a HELOC?
Both loan types allow you to access your home equity, but there are big differences. A home equity loan gives you a lump sum at a fixed rate with fixed monthly payments for a set term. If you need additional money, you'll need to apply for a new loan. Some home equity loan borrowers request more money than they think they need to avoid having to go through the application process again.
HELOCs usually have a variable interest rate, with payments based on how much you've borrowed. If you don't borrow any money, you don't have to pay any interest. You can borrow as much or as little of your HELOC credit limit as you like. As you repay your HELOC, you increase your available credit for future borrowing, similar to how a credit card works. When the initial draw period ends (the time when you can withdraw money and only make interest-only payments), your outstanding balance turns into a term loan similar to a home equity loan.
Bottom line
If you have a bad credit score, you may still be able to get a home equity loan. Certain lenders specialize in borrowers with bad credit, but they may charge higher interest rates and extra fees.
Before applying for a home equity loan, boost your credit score to qualify for the best rates and terms possible. If you don't like your available loan offers, there are other borrowing options that may be a better fit.
Article sources
- Experian, " How to 'Fix' a Bad Credit Score ." Accessed Dec. 28, 2022.
