Having a good credit score or credit history can help in many situations. Especially when trying to take out a loan, such as a home equity loan. A home equity loan is a type of loan that lets you use the equity (value) you have in your home as collateral to borrow money. While it is harder to get a home equity loan if you have a bad credit score, it is possible. Learn more below.
Can you get a home equity loan with bad credit?
Yes, you can. But it is more challenging than if you have good credit. When lenders extend loans to customers, they want to know that the borrower will pay back the loan on time. Having a good credit history shows that a borrower is reliable. A bad credit history or credit score may scare lenders away. So, what is considered “bad credit”?
Many lenders use FICO credit scores to see whether a borrower has good or bad credit. Your FICO credit score is based on how you manage credit. This includes payment history and applications for credit. According to Bankrate, a FICO credit score below 580 equals a poor credit rating. You can still get a home equity loan with poor credit, but it will be more difficult.
| FICO Credit Score | Credit Rating |
| 800-850 | Exceptional |
| 740-799 | Very Good |
| 670-739 | Good |
| 580-669 | Fair |
| 300-579 | Poor |
What is a home equity loan?
As we mentioned earlier, a home equity loan lets you use the equity you have in your home as collateral to borrow money. Home equity loans are sometimes called second mortgages because you now have to make another loan payment along with your mortgage. When you take out an installment loan like a home equity loan, there is a fixed amount that you must pay every month until the loan is completely repaid. Home equity loans often can be paid off over several years.
Home equity loans are not the same as a home equity line of credit (HELOC). The difference is, a home equity loan gives borrowers a lump sum of money with a fixed interest rate. A HELOC provides cash access when you need it, as a line of credit similar to a credit card, but it sometimes has a variable interest rate. That means it can change at any time. Because a home equity loan offers a fixed rate, it may be a better choice than a HELOC if you need a certain amount of money to cover an expense or pay off debt.
How to qualify for a home equity loan with bad credit
Lenders sometimes have different requirements for borrowers looking to take out a home equity loan. At times, these requirements may be difficult to reach if you have bad credit. According to Credible, these are some requirements you must meet to qualify for a home equity loan.
- A credit score of at least 620. A 700 or higher is better.
- A loan-to-value (LTV) ratio of at least 80%. This means you have at least 20% equity in your home.
- A debt-to-income ratio of 43% or less. This means that no more than 43% of the money you earn goes toward paying off debts.
Steps to apply for a home equity loan with bad credit
The best way to successfully apply for a home equity loan with bad credit is to build your credit history. This will make it easier for you to qualify for future loans. In the meantime, here’s how you can apply for a home equity loan.
Review your credit report
Before you apply, review your credit report to see where you can improve your credit score. You can get a free annual credit report It will also let you check for suspicious activity happening with your credit–such as credit cards or accounts that you don’t recognize.
A few quick tips on how to improve your credit score:
- Keep at least one credit card open and active. Make your minimum monthly payments on time.
- Do not open new credit cards unless it’s necessary.
- Keep your credit utilization ratio at 30% or below. Your credit utilization ratio is how much you owe on all your accounts, such as credit cards, compared with your total available credit. This is one of the most important parts of your credit score. Nerdwallet has a quick formula you can use to calculate your credit utilization ratio.
Calculate your debt-to-income ratio
Your debt-to-income (DTI) ratio is very important. It’s the main way lenders can decide whether a borrower is reliable enough to pay off their loan. You can calculate your DTI ratio by adding all your monthly bills, loans, and credit card/debt payments. Then divide that number by your gross monthly income. Multiply that number by 100 to figure out your debt-to-income ratio.
Example: You have $1,000 in debt payments each month. You earn $4,000 per month. $1,000 divided by $4,000 = 0.25. Then, 0.25 x 100 = 25% DTI ratio.
When you apply for a loan, the lender wants to see a debt-to-income ratio of 43% or lower to consider your loan application. The lower your debt-to-income ratio, the better your chances are of being approved for a home equity loan..
Figure out how much equity you have
To figure out how much you can take out in a home equity loan, you need to know what your home is worth. The best way to figure that out is with a professional appraisal, or a professional opinion of a home’s value. One thing to keep in mind…the average cost to have a home appraised is between $300 and $500. The value is determined through an in-person inspection as well as recent sales of similar homes in your area. Also considered are the size, condition, floor plan, and features of your home.
Consider a co-signer
If your credit isn’t good, having someone with better credit–like a friend or family member–co-sign the loan can help you get approved. You should know, however, that if you don’t pay back the loan on time, both your credit score and the co-signer’s credit score can be damaged.
Assess different lenders for the best rates
Finding low interest rates on a loan when you have bad credit isn’t easy. So, you should research different lenders and shop around for the lowest rates. Read the fine print to make sure there are no hidden fees or requirements you can’t meet.
Think about alternatives to bad credit home equity loans
- Cash-out refinance loan: A cash-out refinance loan pays off your existing first mortgage. This is different from a home equity loan, which adds a “second mortgage.” This type of loan results in a new mortgage that may have different terms than your original mortgage. You’ll get a new monthly payment schedule to follow so you can pay off the loan on time. A cash-out refinance pays one lump sum of money. Much of that is used to pay off your existing mortgage. The rest of the money goes to you.
- Personal loan: Instead of a home equity loan, you could take out an unsecured personal loan (if you qualify). An unsecured personal loan provides you with the money you need but doesn’t require you to put up any collateral. We are perfect for people who need a loan but don’t have a great credit history, because we look at more than just a credit score.
Pros and cons of a home equity loan
Getting a home equity loan with bad credit can definitely be a good thing. But there are also some downsides to it.
Pros of a home equity loan
- You’ll have a better chance of qualifying: A home equity loan is a secured loan, meaning that your home is used as collateral. Because the lender is protected by this collateral, borrowers with bad credit often get approval for a home equity loan.
- The loan is flexible: This type of loan can be used to pay off pretty much everything–from unexpected medical expenses or home repair bills, college tuition, and other debts.
- Better interest rates: Because this is a secured loan with your home being used as collateral, the lender can offer lower interest rates than other types of loans.
- You know what to pay and by when: Home equity loans are fixed-rate loans. This means your monthly payments will remain the same throughout the loan. And you’ll know when the loan needs to be paid off by.
Cons of a home equity loan
- You could lose your home: If you don’t pay off your loan, the lender can legally take your home–since you used it as collateral–and sell it.
- Your home needs to have enough equity: Lenders often require that you have 80% equity in your home. If you don’t, you may not qualify for a home equity loan.
- The loan amount could be lower: The amount of money a lender offers depends on your credit score and how much equity is in your home. The worse your credit is, the lower the amount you might be able to borrow.
- There are fees: Since a home equity loan is basically a second mortgage, you will likely have to pay closing costs, appraisal costs, and other fees. This can add up to several hundred or even a few thousand dollars.
- Don’t take out more than you need: With large loans, it may be tempting to take out more money. Only take out what you need, so you won’t end up with larger monthly payments when you repay the loan.
Getting a loan is possible
While it’s certainly easier to get a home equity loan with good credit, it is possible to get one with bad credit. Especially if you need it for emergency purposes. If not, a good approach is to gradually improve your credit score before you borrow money. This will make it easier to get a loan. And it can also help you qualify for better interest rates.