How To Get a Home Equity Loan With Bad Credit

Vault’s Viewpoint on Getting a Home Equity Loan With Bad Credit

• Home equity loans are typically available to borrowers with credit scores of 620 and above.
• If you struggle to qualify for a home equity loan, consider applying with a co-signer and writing a letter to your lender to boost your approval odds.
• Taking time to improve your credit score and DTI ratio before taking out a home equity loan can improve your chances of approval and lead to a more affordable loan.

Can You Get a Home Equity Loan With Bad Credit?

It may be possible to get a home equity loan with a lower credit score, but it could limit your options and affect the loan terms.

When reviewing your application, your credit score is one of the main factors lenders consider because it helps them gauge your risk as a borrower. The FICO Score, which is the most widely used credit score model, ranges from 300 to 850. A “bad” credit score is generally one that falls below 580, and scores between 580 and 669 are considered “fair.” Most lenders require a credit score of around 660 or 680 to get a home equity loan. Some lenders go as low as 620.

The criteria to qualify for a home equity loan are often stricter than the minimum requirements on a traditional home loan. That’s because a home equity loan is considered a second mortgage, meaning your lender gets paid second if you default on the loan. This feature increases risk for lenders, so they’ll often charge higher interest rates and pose stricter requirements to offset that risk. Having a lower credit score also increases the lender’s risk, so they may nudge the interest rate even higher in these cases.

Requirements for Home Equity Loans

When applying for a home equity loan, you (and your property) will typically need to meet these minimum requirements:

Credit History

Many lenders require a minimum credit score of 660 to 680 to get a home equity loan, though some may accept a score of around 620 to 640. The bank will also look over your credit reports to determine the types of accounts you have open, how long you’ve owned those accounts, how much debt you have and whether you’ve generally made payments on time.

Borrowing Limit

Home equity lenders typically allow you to borrow around 85% to 90% of your home’s market value, minus your outstanding mortgage balance. So let’s say your home is worth $400,000, your current loan balance is $250,000 and your lender allows a maximum 90% (loan-to-value) LTV ratio. Here’s how to calculate the amount you can borrow:

1. Multiply your home’s value by the lender’s combined LTV limit. This is the total amount of debt you can take out against your home:

$400,000 x 0.90 = $360,000

2. Take that number and subtract the balance of your first mortgage from it. The result is the maximum amount you can borrow with a home equity loan:

$360,000 – $250,000 = $110,000

In this example, you can borrow up to $110,000, and you retain 10% equity. Lenders usually want you to keep some equity in the home because it reduces their risk. Having a sizable amount of equity in your property may help offset a lower credit score, so it may help you qualify for a home equity loan.

Debt-to-Income Ratio

Your debt-to-income (DTI) ratio shows a lender how much of your monthly income goes toward paying down debt. Lenders want to know you have enough funds to cover your current monthly bills plus the new home equity loan payment, so the percentage of your income that goes toward your overall debt typically can’t exceed 50%. Having a very low DTI ratio may help you qualify for a home equity loan when you have a lower credit score.

Get a Home Equity Loan With Bad Credit

If you have bad credit, here are some steps you can take to potentially qualify for a home equity loan:

Pull Your Credit Reports

About 20% of Americans have an error on at least one of their credit reports, according to a Federal Trade Commission study. Your credit score is based on the information in your credit reports, so inaccuracies can drag down your score. That’s why it’s so important to comb through your credit reports on a regular basis.

You can get a free copy of your TransUnion, Experian and Equifax credit reports from AnnualCreditReport.com once a week or use a third-party credit monitoring service to view them. Look for errors that might be impacting your credit scores, and dispute any credit report information that’s wrong. Your credit score may improve soon after, which can help you qualify for a home equity loan.

Check Your Credit Score

You can check your credit score for free through a few avenues, including free tools like American Express MyCredit Guide™ and CreditWise from Capital One (which don’t require you to own Amex or Capital One products to utilize).

If you’re just shy of a lender’s minimum requirements, you can take steps to improve your credit score. Making on-time payments on all of your credit accounts is one of the best ways to get there. Eventually, you may raise your credit score enough to qualify for a home equity loan.

Calculate Your Debt-to-Income Ratio

It’s also a good idea to check whether your DTI ratio is holding you back from getting a home equity loan. Here’s a quick way to check your ratio:

• First find your gross (pretax) monthly income for the household. For example, let’s say it’s $8,000 per month.
• Then add up your monthly debt payments, such as your mortgage, auto loan, student loans and credit card minimum payments. Let’s say you spend $2,800 toward these expenses each month.
• Divide your total monthly debt payments by your gross monthly income.

Here’s how you would do the calculation: $2,800 ÷ $8,000 = 35%

In this example, your DTI ratio is 35%. Many lenders require a DTI ratio of 50% or less, but your potential home equity loan payment must also fit within that limit. If this area needs improvement, you can focus on paying down some of your debts or adding a second income stream to boost your DTI ratio.

Check Your Home Equity

To calculate your home equity, you’ll need to find your home’s current market value and subtract your outstanding mortgage balance. Using a website like Zillow, Redfin or Realtor.com can help you ballpark your home’s market value, but your lender will likely order an appraisal or broker opinion of value to confirm the information.

Once you calculate your home equity, check whether you have enough to take out a loan and still have 10% to 20% left over. Lenders are usually willing to lend up to 90% of your equity, though some allow for more. If you haven’t built enough home equity yet to take out a loan, you may need to hold off on the application.

Look for Ways To Improve Your Application

There are other ways to bolster your loan application. Here are some to consider:

• Add a co-signer. A creditworthy co-signer with reliable income may help you qualify for the home equity loan. However, your co-signer should understand they’re equally responsible for making payments if you default on the loan.
• Talk with your current lender. It might be easier to qualify for a home equity loan with a lender you have a relationship with, such as the bank or credit union where you do your banking or have an existing loan.
• Write a letter of explanation. This is a brief document you can write to address a lender’s questions about your loan application. For instance, you may explain a negative item in your credit history, employment status or financial situation. It may help improve your chances of qualifying for the loan.