Having a bad credit score can make it harder to get approved for a loan. Fortunately, you can still qualify for a home equity loan, even if your credit is less than ideal. By taking out a home equity loan, you might even be able to improve your credit score by making consistent, on-time loan payments.
But just because you might be able to get a home equity loan doesn’t always mean you should. It’s important to consider the benefits and drawbacks of taking out such a loan before you apply. This will help you make sure it’s the right decision for your unique financial situation.
Credible doesn’t offer home equity loans, but you can compare prequalified mortgage refinance rates from multiple lenders in just a few minutes.
A home equity loan is a second mortgage that lets you borrow against the equity in your home. Equity is the difference between your mortgage balance and the current value of your home. If you qualify, you’ll receive a lump sum of money that you can use for nearly anything, including debt consolidation, medical expenses and paying for big-ticket items.
Like personal loans, home equity loans are installment loans. This means you must make fixed monthly payments over a set period of time until you pay back what you borrowed.
Your monthly payments will typically include the principal balance plus any interest and lender’s fees (like origination fees for processing the loan application). If you consistently make on-time payments, you’ll be able to pay off the entire loan by the end of the repayment term.
Home equity loans can be a great tool if you know how to use them. For example, you could use one to renovate your home — instead of a home improvement loan — to further increase the value of your property. Or you could consolidate high-interest debts into a loan with a lower interest rate.
This type of financing might be easier to get than other loans — like unsecured personal loans — if you have bad credit. They may also have lower interest rates because the loan is secured with your home as collateral.
But these loans aren’t for everyone. Your borrowing amount and interest rate both depend on your credit score, income and debt-to-income (DTI) ratio. To qualify, you’ll also need to have enough equity in your home. Most mortgage lenders will limit your borrowing amount to a maximum of 80% of your home equity.
Additionally, because home equity loans are secured with your property, the lender could foreclose on your home if you fail to make payments.
Your credit score plays a vital role in determining if you’ll qualify for any type of financing, whether it’s a home equity loan or home equity line of credit (HELOC). Minimum credit score requirements will vary among lenders. But you’ll likely need good to excellent credit to qualify for a home equity loan.
Typically, a credit score of 670 to 739 is considered "good credit." The better your score, the higher your approval odds for loans, lines of credit and other forms of financing. Additionally, if you have a higher credit score, you’re more likely to qualify for lower rates and better terms.
Here are several factors that make up your credit score:
Other factors like recent bankruptcies, foreclosures and errors on your credit report can also negatively impact your credit score.
If you’re not sure where your credit stands, you can request a free copy of your credit report online. Review it carefully for any areas that need work. Check for errors, such as incorrect late payments or charge-offs, and dispute them with the appropriate credit bureau to potentially boost your score.
If your credit needs some work, here are a few ways to boost your score:
Debt-to-income (DTI) ratio is another important factor that lenders consider when deciding whether to approve your loan application. Your DTI ratio is how much of your monthly income goes toward paying off existing debt, expressed as a percentage.
To determine your DTI ratio, add up all of your monthly debt payments, including student loans, credit cards, mortgage or rent, or child support. Then, divide that amount by your gross monthly income.
For example, say you make $4,500 a month and spend $2,500 on debt payments. Your DTI ratio would be 56%.
Although your DTI ratio doesn’t directly affect your credit score, you might not qualify for financing if yours is too high. To qualify for a home equity loan, aim to keep your DTI no higher than 43%.
If you have poor or fair credit, here are several types of home equity loans to consider:
WHERE TO FIND HOME LOANS FOR BAD CREDIT
Taking out a home equity loan with bad credit or limited credit history comes with several benefits, including:
Before applying for a home equity loan, here are some downsides to consider:
Although you may qualify for a home equity loan with bad credit, it might be better to improve your credit score before applying for one. This is because your credit score plays a major role in determining if you can get a loan.
Review your credit report for errors, make on-time payments on all of your bills, and lower your credit utilization to boost your credit score. By improving your credit, you can increase your approval odds and qualify for better rates and terms.
If you decide a refinance is a better fit for your financial goals, you can compare mortgage refinance rates from multiple lenders in minutes using Credible.
