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How To Get a Home Equity Loan With Bad Credit

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What You Need To Know

  • A home equity loan can unlock the available equity in your home if you have the credit to qualify
  • There are concrete steps you can take to improve your credit if you want to get a home equity loan
  • If a home equity loan isn’t possible, there are alternatives

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If you need money for renovations, repairs, emergencies or debt consolidation, a home equity loan is a great way to borrow the money you need at a low interest rate.

But, if you’re dealing with bad credit or other money issues – like a high debt-to-income (DTI) ratio or not having enough home equity – you may be wondering if you’ll qualify for a home equity loan.

Here’s the good news: There are ways to improve your financial situation and increase your chances of qualifying for a home equity loan. 

Before we dive into strategies to help boost your chances of getting a home equity loan, let’s have a quick refresher on what a home equity loan is.

What Is a Home Equity Loan?

A home equity loan (sometimes called a second mortgage) lets you borrow a lump sum of money against your home’s equity (the value of your home minus what you owe on your mortgage). 

A home equity loan is a secured loan, which means your house is used as the security (aka collateral) for the loan. Because the loan is secured, the loan’s interest rate is likely to be lower than the interest rates on unsecured options like credit cards or personal loans.

You can usually get a home equity loan from most traditional lenders, like a bank or credit union as well as online lenders. 

You pay back the loan (plus interest) in fixed monthly installments during a set period, typically ranging from 5 – 30 years. And, like your primary mortgage, the closing costs for a home equity loan can range from 2% – 5% of the loan’s value. 

There are similarities between a home equity loan and a home equity line of credit (HELOC). So, what’s the difference? Like a home equity loan, a HELOC taps into your home’s equity. But instead of getting a lump sum of money, a HELOC works like a credit card.

Ways To Improve Your Financial Situation To Get a Home Equity Loan 

Ready to consider applying for a home equity loan but need to improve your current financial situation? Use our recommended strategies to improve your chances of getting a home equity loan (we even added a bullet for home equity loan alternatives): 

  • Increase your home equity
  • Improve your credit score
  • Lower your DTI
  • Find a co-signer
  • Get help with your debt, spending and credit
  • Find home equity loan alternatives

1. Increase your home equity

First, it’s important to understand how much you can borrow and how home equity affects your ability to get a home equity loan.

Your lender won’t let you borrow against the total value of your home. Usually, what you owe and what you plan to borrow can’t exceed 80% – 85% of the home’s value. This amount is often referred to as your combined loan-to-value (CLTV) ratio.

This isn’t a fixed amount. You can build home equity by:

Paying your mortgage faster

Making an extra mortgage payment each year or paying a little extra toward your mortgage principal each month can help lower what you owe because all the extra money will go toward paying down your loan balance (aka the principal), not interest. 

Getting your home reappraised

Home values can change with the market. The current value of your home may go up or go down over time. 

Do your research. See if similar homes in your area have increased in value, and if that’s a yes, find out by how much. 

If you feel your home’s value has increased, you can request a reappraisal. A professional appraiser can perform a home inspection and/or compare your home’s value to the value of similar homes in the area. If your home’s value has increased, your equity can get a much-needed boost!

2. Improve your credit score 

Your credit score is a number between 350 – 800 that determines your creditworthiness. This number is determined based on your:

  • Credit utilization ratio: It’s the amount of credit you owe divided by the total amount of credit you can borrow.
  • Payment history: This is an accounting of any late or missed payments.
  • Credit history and credit diversity: It’s a summary of how long you’ve been using credit and the types of credit you’ve used.

When you first bought your home, you probably needed a minimum credit score of 620 or higher, unless you got your mortgage using a government-backed loan program, such as a Federal Housing Administration (FHA) loan or Department of Veterans Affairs (VA) loan

To qualify for a home equity loan, lenders will typically prefer a credit score of around 680 – 700 or higher.

You may still qualify with a lower credit score, but you’ll pay more in interest. That difference in interest can add hundreds to your monthly payment and thousands to the total amount you’ll pay over the life of the loan. 

To improve your credit score you can:

Keep an eye on your credit report

You can access a free copy of your credit report each year. (The three major credit bureaus are TransUnion®, Equifax® and Experian™.) Look through your reports and see if there are any red flags, like unpaid bills, unfamiliar activity or unfamiliar accounts. 

Stay on the lookout for any errors, fraud, or identity theft that could be hurting your score. And, if you find any, notify the appropriate credit bureau, pronto!

Pay your bills

If you have late payments or bills, pay them as quickly as possible. And make sure to keep paying your bills on time and in full. If you can afford it, set up autopay and give yourself the peace of mind that your bills are getting paid on time each month. 

Lower your debt

Your credit score depends on how much money you owe – especially when it comes to high-interest debt (like credit cards). 

To boost your credit score, you’ll need to lower your credit card debt.

Create a budget that focuses on lowering your expenses, and then create a plan to aggressively pay down your debts using the debt snowball method or debt avalanche method.

Each method focuses on paying down one balance at a time as quickly as possible. 

With the debt snowball method, you pay off your smallest debt first (while paying the minimums on your other debts). Once you’ve paid off your smallest debt, you move on to your next smallest debt until you’re debt-free.  

With the debt avalanche method, you pay off your debt with the highest interest rate first (while paying the minimums on your other debts). Once you’ve paid that off, you’ll move on to your next highest-rate debt until you’re debt-free. 

3. Lower your DTI

Your debt-to-income (DTI) ratio gives lenders insight into how you manage your money. To figure out your DTI, add up all of your fixed monthly payments (think: credit cards, personal loans, student loans, auto loans and mortgage payments). Then take that result and divide it by your gross monthly income (what you make before taxes and payroll deductions). 

Or you can use our DTI calculator and let us handle the math! Pro tip: The lower your DTI, the better.

Debt-to-Income Calculator

Itemize Debt for Most Accurate Result
Your debt-to-income ratio…

❓   Curious what your debt-to-income (DTI) ratio is? Enter your figures and let the magic begin!

What Is DTI?

🟢   On Track – Hey money maestro! You’re right on track for your house-buying journey! Make sure you have all the information you need to make the right choice.

How much can I afford?

🟢   On Track – You’re right on track for your house-buying journey!

How much can I afford?

🚨   Above Recommended DTI – Some lenders have different requirements to qualify but it’s worth looking into your credit and finding out what you can afford within your budget.

What Is DTI?

🚨   Too Much Debt – Seems like you’ve got a little too much debt to qualify with the income you’ve put in! Do you want to try again?

Ideally, lenders look for a DTI of 40% or less, though they may be able to accommodate you with a DTI of up to 50% if you have good credit. Anything above 50% will be a big red flag.

To improve your DTI, you’ll either need to lower your debt (the D of DTI) or look for ways to increase your income (the I of DTI). Consider asking for a raise, turning a hobby into a side hustle or becoming an influencer (you never know!).

4. Find a co-signer

If you can’t get a home equity loan on your own, consider a co-signer – a friend or family member with good credit who’ll sign the loan with you and agrees to pay back the loan in case you can’t. 

When you get a co-signer, lenders base their decision to offer you a loan on both your credit score AND your co-signer’s credit score. You’ll need a co-signer with excellent credit and a low DTI to improve your chances of qualifying for a loan.

5. Get help

If you’re struggling with debt, credit or spending and you’re not sure how to improve your situation, go ahead and ask for help – because help is out there!

  • Talk to a debt counselor. They can help you figure out a budget and may be able to offer solutions to help you resolve your debt issues and improve your credit.
  • If you’re having trouble with your credit cards, try calling the credit card company to see if they can work out a payment plan with you.
  • If it’s an option, reach out to family (and maybe even friends) for help. They may be able to connect you to a family bank or financial advisor who can help you figure out how to manage your debt.

6. Explore alternatives to home equity loans

Home equity loans aren’t the only game in town. Let’s explore a few alternatives:  

Cash-out refinance

If you have enough equity and qualifying credit, you can take advantage of a cash-out refinance. A cash-out refinance replaces your original loan and lets you pocket the difference between how much your house is worth and what you still owe on it. Cash-out refinance is almost always the cheapest way to borrow from your home equity.

FHA Limited 203(k) mortgage loan

Even if you didn’t finance your home with an FHA loan, you may be able to take advantage of an FHA Limited 203(k) mortgage loan. These loans let you borrow up to $35,000 for home repairs and improvements. 

Best of all, because the loan is government-backed, so you can qualify with a credit score as low as 580.

Personal loan

If you don’t have enough home equity to qualify for a home equity loan, you may be able to qualify for a personal loan. You may pay more in interest, but you’ll be able to get the money you need in less time.

From Bad Credit to a Good Home Equity Loan

Lower range credit scores are pretty common. According to Experian™, 30% of Americans have a “poor” credit rating.[1] And yet, some of them have managed to get home equity loans.

So, don’t let your current credit score stand in the way of improving your financial situation and applying for a home equity loan. After all, there are ways to improve your credit score and increase your chances of qualifying for a home equity loan. 

And like we said: Home equity loans aren’t the only game in town. 

  1. Experian™. “Experian 2020 Consumer Credit Review.” Retrieved September 2021 from https://www.experian.com/blogs/ask-experian/consumer-credit-review/

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In Case You Missed It

Take-aways

  1. Your combined loan-to-value (CLTV) ratio (what you owe and what you plan to borrow) can’t exceed 80% – 85% of your home’s value
  2. If you’re looking to improve your credit, you may want to get help with a debt repayment plan
  3. If you don’t qualify for a home equity loan, there are other options out there, like FHA Limited 203(k) mortgage loans, personal loans or a cash-out refinance

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