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A tarnished credit score can make it really difficult for you to get a home equity loan or a home equity line of credit aka HELOC, even though you may have plenty of equity in your home. So, how do you get a home equity loan with bad credit?
Although you need a credit score of at least 620 to qualify for a home equity loan or HELOC, you still stand a chance if your credit is less than that. Fortunately, getting a home equity loan with bad credit or no credit history is not impossible. But, your loan options will depend on how poor your credit is. And, it will cost you more in all likeliness.
Nevertheless, if you’re really looking for a loan option, whether to buy a home, pay for college, debt consolidation, or a major home repair or upgrade, this is indeed good news.
What Is a Home Equity Loan?
A home equity loan is a type of loan whereby you can borrow funds against your home equity. Simply put, you can use your house as collateral for borrowing money. Keep in mind that such a loan does not replace your first lien mortgage loan, but is an additional loan.
Generally, you can borrow only up to 75 to 80% of the loan-to-value ratio in your home. An important fact to consider is that if your current first lien mortgage loan is already at 80 percent of your home value, you may not qualify for a home equity loan.
But if you do, an advantage of a home equity loan is that the interest you pay on it may be tax-deductible — of course depending on what you are using the money for. In most cases, if you’re taking a loan to fund a home remodeling project that increases its value, you will get benefits. You can confirm the exact details with your tax advisor.
How Do You Calculate the Equity in Your Home?
The equity you have in your home is the difference between the total loan amount you owe on your home and what it’s worth. Needless to say, your equity grows as you pay down your mortgage or if your property value goes up on the real estate market.
Home Equity Loan With Bad Credit
If you have a bad credit score, a home equity loan is easier to get as compared to other traditional loans or a revolving line of credit. And, there’s a reason. Since you use your home as a security or collateral for the loan, you are considered less of a financial risk for a loan lender. The more home equity you have, the easier it is to get a home equity loan approved.
Does a Home Equity Loan Affect Your Credit Score?
Yes, home equity loans can have a direct impact on your credit score, especially if you exhibit a good overall financial situation and make timely payments on the loan amount you borrow. Moreover, a home equity loan also increases the diversity of credit accounts in your credit file, which boosts your credit score.
How to Obtain a Bad Credit Home Equity Loan
Not all money lenders, banks or credit unions have the same guidelines when it comes to home equity loans. Therefore, it’s best to shop around for rates and terms from multiple lenders.
Typically, it’s easier to get a loan approval if you have at least 15 percent equity in your home, good employment history with a stable income, fair credit, on-time bill payment history and a debt-to-income ratio that’s less than 43 to 50 percent.
How to Qualify for a Home Equity Loan With Bad Credit?
Even if you don’t have good or excellent credit, you still have home equity loan options. But, you should be willing to take certain measures to improve your chances. Here’s what you need to do before applying for a home equity loan.
1. Check Your Credit Report
Wouldn’t it be better if you evaluated your credit report before any lender did? It will give you an edge, and you can take preemptive measures to rectify the damage. You can work towards removing any errors and boosting your credit. See your credit report for free once a year at AnnualCreditReport.com.
2. Boost Your Credit Score
The best way to ensure a good loan is to improve your credit and reduce your debt relative to your income. Here’s what you can do:
- Check for any overdue payments.
- Pay bills on time every month.
- Try to pay off the balance amount as soon as possible.
- Don’t close credit cards that can cause your credit score to dip.
- Never max out or open new credit cards.
Fixing your credit will take discipline and time. But once your scores are up, it will boost your creditworthiness significantly.
3. Calculate Your Debt-To-Income Ratio
In order to calculate your debt-to-income ratio (DTI), simply divide your monthly debt (including loan payments, credit card payments, and other financial obligations) by your monthly gross income.
Keep in mind that lenders prefer a low DTI — ideally less than 43 percent. Therefore, you will want to keep your DTI as low as you can.
4. Make Sure You Have Good Home Equity
Lenders prefer that you have a minimum of 15 or 20 percent equity in your home. The more equity you have, the better will be your loan interest rates. Your loan-to-value ratio (LTV) determines your equity. It’s calculated by dividing your remaining loan balance by your home’s current value on the market.
5. Borrow Only What You Need
When applying for a loan, it’s always tempting to ask for more than what’s required. However, just because you’re eligible for a large loan amount doesn’t mean you should. It’s best to borrow only what you need by setting a credit limit. Keep in mind that borrowing money in excess will only increase your monthly payments and the total loan interest.
6. Compare Different Interest Rates
The rule of thumb is that the lower your credit score, the higher will be your interest rates. So, if you have a poor credit score, you will end up paying much more than a borrower with excellent credit — for the same loan size. Keeping that in mind, it’s a wise decision to weigh all your options and interest rates before zeroing on a particular loan type.
7. Get a Co-Signer
If you have bad credit and hence do not qualify for a loan on your own, you can always get a co-signer to help your financial situation. A co-signer basically applies for your home equity loan with you and is equally responsible for paying back the loan. This means that if you, the primary applicant, fall behind on the loan repayments, your cosigner’s credit will suffer too.
Home Equity Loan Alternatives for Borrowers With Bad Credit
If after all the above steps, you still do not qualify for a home equity loan, maybe it’s time to consider other financing options.
There are a few lenders who offer personal loans to low-score borrowers. However, since a personal loan has shorter repayment terms (five or seven years), your monthly payments will be high. And if your credit is poor, your interest rate will be much higher than in the case of a home equity loan.
But, while you might not need good equity in your home for such an unsecured personal loan, you will require a good credit score or a co-signer with one.
With a cash-out refinance, you get a new, larger loan with which you can pay off your existing mortgage while pocketing the difference in cash. A minimum of 20 percent of home equity is required for a cash-out refinance.
Loan experts advise you for a cash-out refinance only if you can get an equal or lower interest rate. Otherwise, you’ll end up paying more towards interest over the life of your loan (15 to 30 years). Furthermore, refinancing a mortgage comes with high lender fees and closing costs.
The amount of equity you have in your home can be a powerful asset in times of financial need. It makes a home equity loan, even with bad credit, a possibility.
You can simply tap into the equity and borrow funds to enable a home improvement or a remodeling project or a debt consolidation.