Can you get a home equity loan with bad credit?

While getting approved for a home equity loan isn’t a guarantee with any credit score, the application process is more rigorous with bad credit. However, there are several steps you can take to increase your odds of approval.

If you’re wondering how to get a home equity loan with bad credit, here’s what you should know.

What credit score do you need to get a home equity loan?

Many lenders require good or excellent credit to qualify for a home equity loan. Typically, the minimum credit score needed for a home equity loan ranges from about 670 to 680. However, some lenders accept scores as low as 620, which means you could still qualify if you have fair credit.

Keep in mind that your credit score will also affect the rates you’re offered on a home equity loan. In general, you’ll need good to excellent credit to qualify for the best home equity loan rates.

How to get a home equity loan with bad credit

If you’re ready to apply for a home equity loan with bad credit, follow these steps:

1. Calculate your home equity

You’ll need to have sufficient equity in your home to qualify for a home equity loan — usually at least 20%, depending on the lender. You can determine your total home equity by subtracting your mortgage balance from your home’s current appraisal value. 

For example: If you have a home valued at $350,000 and still owe $100,000 on your mortgage, then you have $250,000 in equity.

2. Estimate how much you can borrow

Lenders will use the amount you have in equity to determine how much you can borrow with a home equity loan based on your loan-to-value (LTV) ratio. This compares how much you owe on your mortgage with the appraised value of your property. 

Here’s how it works:

1. Determine your home value. First, estimate the current market value of your house. One way to do this is by typing your address into a real estate marketplace website to get a free initial quote. 
2. Estimate your maximum LTV ratio. Most lenders let you borrow up to 80% of your home value (maximums can be higher for well-qualified borrowers). In other words, you can have an LTV ratio of up to 80%. To calculate your LTV ratio, you’ll divide your current mortgage balance by the appraised value of your home. 
3. Subtract your remaining mortgage balance. An outstanding mortgage reduces your available equity. Deduct your current mortgage amount from 80% of your home’s value to estimate your potential loan amount. 

For example: A $350,000 home has a maximum $280,000 borrowing limit with an 80% LTV ratio. If you have a $225,000 remaining home loan balance, you can borrow as much as $55,000 with a home equity loan.

3. Calculate your DTI ratio

In addition to needing sufficient credit and equity, you’ll also need a qualifying debt-to-income (DTI) ratio. This measurement helps determine if you can afford a home equity loan payment. Most lenders prefer a DTI of 43% or below for a home equity loan. 

To calculate your DTI ratio:

1. Add up all of your monthly debt obligations. This includes installment loans (such as a mortgage, personal loans or student loans) and revolving credit lines (such as credit cards and lines of credit).
2. Divide this by your gross monthly income. 

For example: If you have a total of $2,500 in monthly debt expenses and earn $6,000 each month, your DTI ratio is about 42%.

4. Compare lenders and pick a loan option

Before you apply, be sure to shop around and compare options from as many home equity loan lenders as possible. This way, you can find a loan that works for your situation. Consider factors like interest rates, terms and fees as you weigh your choices. Also check each lender’s qualification criteria — some are easier to work with if you have bad credit compared to others.

Some lenders let you pre-qualify for a home equity loan with only a soft credit check that won’t hurt your credit score. This will give you an idea of what rate and terms you might get approved for if you apply.

After you’ve done your research, pick the loan option you like best.

Find the right loan for you: Compare the best home equity loan lenders

5. Submit an application and provide documentation

Once you’ve picked a lender, you’ll need to submit a formal application for a home equity loan. This process is similar to getting a mortgage and will require an appraisal of your home, which the lender will typically set up. 

You’ll also need to provide documentation. In addition to the standard documents such as proof of income and tax returns, it can be a good idea to include a letter of explanation explaining why you might have damaged credit.

“If you’ve had some tough times (that led to having bad credit), write a letter of explanation to lenders along with your application,” says David Berns, a financial planner with Truadvice Wealth Management. “By providing supporting documents about what happened during that time, it’ll resonate more with the lender and could help you qualify for the loan.”

Tip: If you’re having a hard time qualifying on your own, you might consider applying with a co-signer or co-borrower. This can be a trustworthy friend or relative who has good or excellent credit and a steady income, which can increase your approval odds. It can also qualify you for better interest rates and more favorable terms than you’d get alone.

Just keep in mind that a co-signer will be liable if you as the primary borrower fail to make your payments. A co-borrower, on the other hand, will be equally responsible from the start of the loan. Additionally, not all lenders permit co-signers or co-borrowers, so you’ll have to double-check before you apply.

6. Close on the loan and get your funds

If you’re approved, the lender will set a closing date for the loan. The average time to close on a home equity loan is typically two to six weeks, depending on the loan’s complexity. Note that you’ll also have to pay closing costs for a home equity loan, just like you did with your original mortgage. These are generally 2% to 6% of the loan amount.

Once the loan is closed, you’ll receive your funds in a lump-sum disbursement to use however you’d like.

Tips for building your credit score

If you can wait to take out a home equity loan, it can be worth taking the time to build your credit so you can get approved more easily in the future. This will also help you qualify for better interest rates.

Here are some strategies that could improve your credit over time:

• Review your credit reports and fix errors. You can view your full credit report from each of the three credit bureaus at least once a year. Keep an eye out for any errors — if you find any, dispute them with the appropriate credit bureau to potentially boost your credit score. You could also consider enrolling in a credit-monitoring service to get weekly or monthly updates. 
• Make on-time payments. Your payment history comprises 35% of your FICO credit score. By paying all of your bills on time, you can strengthen your credit score over time. Consistently meeting payment deadlines can also increase a lender’s confidence that you won’t default. Note that while on-time payments will help your credit, late payments can remain on your credit reports for up to seven years.
• Pay down revolving account balances. If you have revolving credit lines — such as credit cards or lines of credit — strive to keep your balance below 30% of your total credit line. This is also known as your credit utilization, which is the second largest component of your credit score.
• Pay down existing debt. Paying down existing debts can help to improve your DTI ratio as well as your credit utilization (if you pay down revolving credit lines). Note that lenders like to see you can responsibly manage multiple types of credit, so paying off debts might actually cause your credit score to dip a little.
• Avoid opening new accounts. Try not to open new credit accounts or take out new loans unless necessary. Each application can result in a hard inquiry, which can temporarily reduce your credit score by a few points. Opening too many accounts at once might also make it appear to lenders that you’re struggling financially. 

Take control of your credit: Learn how to fix and repair bad credit

Alternatives to a home equity loan

If you don’t qualify for a home equity loan or it doesn’t seem quite right for you, here are some alternatives to consider:

Personal loans

While many lenders require good to excellent credit, others offer personal loans for bad credit. Keep in mind that these loans can come with higher interest rates, smaller loan amounts and more fees compared to good credit loans.

Most personal loans are unsecured. However, some lenders provide secured loans that require collateral, such as your vehicle. Because this is less risky for lenders, secured personal loans can be easier to qualify for with bad credit. They also tend to have lower interest rates. However, you could lose your property if you don’t make your payments.

HELOC

A home equity line of credit (HELOC) is another option to borrow against your equity. However, instead of receiving a lump sum as you would with a home equity loan, you’ll have access to a revolving credit line that allows you to make repeated withdrawals. This can be helpful if you aren’t sure how much you need to borrow or have recurring expenses to cover.

To qualify for a HELOC, you’ll have to meet similar requirements as you would with a home equity loan.

How much can you borrow? Use our HELOC calculator to find out

Cash-out refinance

If you have at least 20% equity in your home, you could also be eligible for a cash-out refinance. This financing method replaces your current mortgage with a new, larger loan. You’ll receive the difference as a lump sum to use how you’d like.

Ready to refinance? See the top mortgage refinance lenders

Frequently asked questions (FAQs)