If you are a homeowner, one of the types of loans you could be qualified to get is a Home Equity Loan. A home equity loan provides you with a large, lump-sum amount of money that you can pay back in monthly fixed installments with a fixed interest rate. You can use a home equity loan if you want to make improvements in your house, to pay for a large expense, or to cover your existing debts.
But what if you have a poor credit rating? Can you still get a home equity loan as long as you own a house? The answer is YES.
In this article, we will look at the factors that affect your eligibility to get approved for a home equity loan. We will also provide you with some tips on how to improve your chances of getting one even if you have a low credit score.
What Is A Home Equity Loan?
A Home Equity Loan is a type of loan that homeowners can get by putting their home equity as a guarantee to secure the loan. The term “Home Equity” refers to how much of your house you already own.
For example, if you are still paying a mortgage, your home equity is calculated by subtracting the amount you still owe from the current appraised value of your house. Let’s say your house is appraised at $500,000 today and you still owe your lender $150,000. Your home equity is $350,000 or 70% of the home value. However, if you own your home outright, meaning you are mortgage-free, then your home equity is 100% or $500,000.
Keep in mind that the more equity you have on your house, the higher your chances of getting approved for the loan. Because your house is used as a guarantee, you are considered a lower risk to lenders, even if you have a poor credit score. If in any event you are unable to pay back the loan, the lender can foreclose or take your house. This makes it easier for homeowners to get a home equity loan compared to other unsecured loans.
How is Home Equity Loan Different From HELOC?
Both Home Equity Loans and HELOC (Home Equity Line Of Credit) use your home equity as collateral for your loan. But unlike a home equity loan that gives you a one-time payment with fixed interest rates, a HELOC functions like a credit card that allows you to draw money over a 5-10 year period with variable interest rates. With a HELOC, you only pay the minimum interest during the draw period and the payment plan starts after that period. With a Home Equity Loan, your payment plan starts immediately
I Have Bad Credit, Can I Still Get A Home Equity Loan?
Yes, you can. Credit score is not the only aspect that will be considered when a lender reviews your home equity loan application. Even with poor credit, different factors could increase your chances of getting approved for a home equity loan.
Common Requirements In Getting A Home Equity Loan
Not every homeowner is qualified to get a home equity loan. Below are some of the criteria often used by lenders who offer home equity loans:
1. Minimum Credit Score
A borrower’s credit score is still being used as a criterion when it comes to home equity loans. Usually, the minimum credit score for home equity loans required by lenders is 620. However, this is not the only criteria as other factors could increase your chances of getting approved for a home equity loan. Plus, there are some lenders who specialize in lending to homeowners with bad credit.
2. Home Equity
Your home equity is one of the most important factors that will be considered when getting a home equity loan. Many lenders usually require that you have a home equity of 15% to 30% of your home, but some lenders require you to have more equity.
The good news for people with bad credit scores is that you could have a higher chance of getting a home equity loan if you have more equity or if you own your home outright already.
For instance, if your credit score is 620 but you own your home 100%, your chances of getting a home equity loan with better terms could be higher than someone who may have a slightly higher credit score of 650 but only has a home equity of 30%.
3. Loan-To-Value Ratio
Another term that you will encounter when looking to get a home equity loan is loan-to-value ratio or LTV. LTV refers to how much money you still owe in relation to the current value of the house. The lower your LTV is, the better. When you have low LTV, that means your home equity is high because you owe less money. If you don’t owe any more money, your current LTV is zero.
4. Debt-To-Income Ratio
Your DTI or debt-to-income ratio is another factor that lenders look at when approving your loan application. Your DTI ratio refers to how much debt payments you owe compared to how much you are earning every month. The maximum debt-to-income ratio required by many lenders is not more than 43% to 50%. A lower debt-to-income ratio means that you have more room to pay for another loan and makes you a lower risk to the lender.
5. Employment And Income History
Lenders also look at your employment history in approving your loan. Even if you have a bad credit score, if you can show that you have a stable revenue and source of income, this could help you get approval.
6. Payment History
Usually, lenders will look at how prompt you are in your recent payments. A lender is more likely to consider you favorably if you can show that you haven’t missed any of your bill payments, even if you have a low credit score.
How To Get A Home Equity Loan If You Have Bad Credit?
Getting a home equity loan is still possible even if you have poor credit. You can follow the steps outlined below if you are planning to get a home equity loan.
Step 1: Determine if you have enough equity in your home to qualify for a home equity loan
The first step is to determine whether you have enough equity to qualify for a home equity loan. As mentioned earlier in the article, many lenders require that you have at least 15% to 30% home equity depending on the value of your current home.
To know if you have enough equity, you have to calculate your home equity and loan-to-value ratio.
To calculate your home equity amount, subtract the remaining mortgage balance that you have from the current appraised value of your house.
For example, your house has a $500,000 appraised value and you have remaining mortgage payments of $150,000.
(Current Appraised Value) – (Amount You Still Owe) = Home Equity Amount
$500,000 – $150,000 = $350,000 Home Equity
To know the home equity percentage, you can divide the home equity amount by the current appraised value, then multiply the answer by 100.
(Home Equity Amount) ÷ (Current Appraised Value) = (Answer) x (100) = Home Equity %
$350,000 ÷ $500,000 = 0.70 x 100 = 70% Home Equity
You can calculate your LTV by dividing the amount you still have on your mortgage by the current appraised value of your home, then multiply that by 100 to get the LTV percentage.
For example, you still owe $150,000 and the appraised value of your home is $500,000, the calculation will look like this:
(Amount You Still Owe) ÷ (Current Appraised Value) = (Answer) x (100) = LTV
$150,000 ÷ $500,000 = 0.30 x 100 = 30% LTV
Step 2: Check Your Debt-To-Income Ratio
Checking your debt-to-income ratio is the next step. You can calculate your DTI ratio by dividing your debt payments by your gross monthly earnings then multiplying it by 100.
For example, if your monthly debt payments amount to $2,000 (mortgage, car loan, credit cards, etc.) and your gross monthly income is $5,000, the calculation will look like this:
$2,000 ÷ $5,000 = 0.40 x 100 = 40%
If your DTI ratio exceeds 43%, you might have a hard time qualifying for a loan. You may need to pay off some of your debts before applying.
Step 3: Check Your Credit Report
You might have an idea already that you have a bad credit score, but how bad is it really? Are you certain that your credit report is accurate? An FTC study reports that 1 in 5 people have a mistake in at least one of their credit reports.
By requesting a copy of your credit report, you can keep track of your financial history and see whether the report is correct. You can request a free copy of your credit report from Equifax, TransUnion, and Experian every year. You can visit www.AnnualCreditReport.com to request your free copy.
Once you receive your report, check it carefully. If you find inaccuracies that are pulling your score down, you can seek redress to have these removed from your credit report. When these entries are removed, your credit score could improve.
To file a dispute, you can follow the steps in the link below to have negative entries removed from your credit report.
Step 4: Improve Your Financial Standing
Before you take out a home equity loan or any kind of loan for that matter, try to take steps to improve your financial standing. Even if you have a 620 credit score, which is the minimum score required by most lenders, remember that a higher score will open up better loan terms and interest rates.
Some of the things that you could do to improve your financial history include the following:
- Make timely bill payments. Having a good payment history will reflect positively on your profile as a borrower and it could also strengthen your credit score over time.
- Don’t max out your credit cards and do not make big purchases before your loan application to improve your debt-to-income ratio. If possible, only utilize 30% of your credit limit on your credit cards.
- Pay off as much debt as you can but if you have credit cards, don’t close them altogether. Keep them open to improve your credit utilization ratio (how much money you are allowed to borrow), which affects your credit score.
Step 5: Compare Multiple Lenders
There are now many lenders offering deals to homeowners looking for home equity loans. Before committing to one lender, try to research and check multiple offers from different lenders to find the best deal. When shopping for a lender, make sure that the lender will only run a soft inquiry on your credit report and not a hard inquiry. A hard inquiry on your credit report can hurt your credit score.
How Much Can You Borrow With A Home Equity Loan?
Lenders often allow you to borrow up to 80% of your home equity minus the amount of money you still owe.
To calculate how much you can borrow, use the formula below.
(Current Appraised Value) x 0.80 = 80% of Appraised Value
(80% of Appraised Value) – (Amount You Still Owe) = Amount You Can Borrow
Using the example of you having a house with a $500,000 Appraised Value with $150,000 remaining payments, you can borrow up to $250,000.
$500,000 x 0.80 = $400,000
$400,000 – $150,000 = $250,000
If you want more accurate calculations, you can use home equity loan calculators available online.
Is a home equity loan a good idea?
If you are a homeowner, a home equity loan might seem like a good option because it has lower interest rates compared to other credit options. It is also easier to get because you are using your house as collateral. However, you should also consider the risk involved with getting a home equity loan. Since you are putting up your house as a guarantee, you can lose your home if you default on the payments.
If you plan on using a home equity loan to consolidate your debts like credit card debts, using a home equity loan might not be a good idea. Credit card debts are unsecured debts, meaning they can be discharged in case of bankruptcy. By using a home equity loan to pay them off, you are converting your debts to secured debt, which puts you at risk of losing your home.