If you’re a homeowner, one of the types of loans you could be qualified to get is a Home Equity Loan. It 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, pay for a large expense, or cover your existing debts.
Now, don’t confuse a home equity loan with HELOC (Home Equity Line Of Credit). Both 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. It allows you to draw money over a 5 to 10-year period with variable interest rates.
Generally, you need good credit for a home equity loan, but if you have a poor credit rating, you can still get a home equity loan as long as you own a house. After all, a credit score isn’t the only aspect that will be considered when a lender reviews your home equity loan application.
Will I Qualify for a Home Equity Loan with Bad Credit?
Not every homeowner is qualified to get a home equity loan. Below are some of the criteria often used by lenders:
1. Minimum Credit Score
A borrower’s credit score is one of the top considerations in home equity loans. What is the minimum credit score for a home equity loan?
Usually, lenders require a credit score of at least 620 for home equity loans. Even so, there are lenders that specialize in providing a home equity loan with bad credit. You may be able to get a home equity loan with a lower credit score under 600.
2. Home Equity
Many lenders usually require that you have 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 low 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 FICO 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 the 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 you owe compared to how much you are earning every month.
The maximum DTI required by many lenders is not more than 43% to 50%. A lower DTI 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 lower credit score.
How to Apply for a Home Equity Loan With 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’re planning to get one.
Step 1: Determine If You Have Enough Equity In Your Home
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% equity depending on the value of your current home.
To know if you have enough equity, you have to calculate your equity and loan-to-value ratio.
- Calculate Home Equity Amount
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
- Calculate Equity Percentage
To know the home equity percentage, you can divide the 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
- Calculate Loan-to-value Ratio
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 history 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 report, you can keep track of your financial history and see whether the report is correct. You can request a free copy from credit bureaus (Equifax, TransUnion, and Experian) every year. You can visit www.AnnualCreditReport.com to request your free copy.
Once you receive your report, check your credit history carefully. If you find inaccuracies that are pulling your score down, you can seek redress to have these removed from your 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 record.
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 and make borrowing money easier.
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 Home Equity Loans from 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.
Best Home Equity Loans for Bad Credit
Here are banks that give home equity loans with bad credit and allow people to borrow against their property’s equity. You can apply online through their website and get the results of your application within 6 minutes.
Pros and Cons: Is A Home Equity Loan A Good Idea?
If you’re a homeowner, a home equity loan with bad credit might seem like a good option because it has lower interest rates compared to other credit options. It’s also easier to get because you’re using your house as collateral. You can also use the fund for any purpose.
However, you should also consider the risks involved with getting a home equity loan with bad credit. Since you’re putting up your house as a guarantee, you can lose your home if you default on the payments. That will further hurt your already low credit standing.
If you plan on using a home equity loan for debt consolidation like credit card debts, using this type of loan might not be a good idea. Credit card debts are unsecured debts, meaning they can be discharged in case of bankruptcy. By using an equity loan to pay them off, you’re converting your debts to secured debt, which puts you at risk of losing your home.
How Much Can You Borrow With A Home Equity Loan?
Most lenders will allow you to borrow up to 80% of your 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 equity loan calculators available online.
Alternative Home Equity Financing
If you can’t get approved for a home equity loan with bad credit, here are your options for financing:
A personal loan can be used for any purpose. Lenders typically require good credit standing, but there are also banks that cater to bad-credit borrowers. Remember though that a personal loan may have higher monthly payments compared to home equity loans.
Cash out Refinance
Cash out refinance means paying off your current mortgage with a new loan. It’s higher than your existing mortgage so you get to keep the difference. However, you’ll be paying high interest over the life of the loan, plus there are other fees to pay.
If you need to borrow money to finance a home renovation, pay bills, or consolidate your debt, a home equity loan is an option even when you have bad credit. However, make sure that you weigh in your options so that it will help you get back on track with your finance rather than further hurt your already poor credit score.