How to Get a Home Equity Loan If You Have Bad Credit
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If you need a loan but are put off by rising interest rates, a home equity loan might be a fitting solution. Since it's secured by an asset — your home — rates are often lower than what you’d find with a personal loan. However, it comes with its own set of qualifications. If your credit score is under 620 or if you already have a lot of monthly debts, you may find it difficult to qualify.
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This doesn’t mean it’s off the table entirely. Understanding lenders’ financial requirements will help you strengthen your application, or you may determine that a different loan is a better fit for your needs once you know all of your options.
How to get a home equity loan with bad credit
Request a free credit report and check it for errors. You can dispute anything that’s wrong, since an error might be artificially lowering your credit score. If your score is lower than 620, this could make it difficult to qualify for a home equity loan with many lenders.
Calculate your debt-to-income ratio. This is the amount of monthly debts you’re obligated to pay, relative to your monthly income. The lower this number is, the better. Lenders ideally want to see a ratio of 43% or less.
Learn how much equity you have in your home. Lenders are typically willing to lend up to 80% of your equity, though some allow for much more.
Consider getting a co-signer. This may help you qualify for a home equity loan, but it comes with risk. If you can’t make your loan payments, the co-signer will be on the hook.
Try a familiar lender. You may have an easier time qualifying for a home equity loan by going to a lender that you already have a relationship with, such as the one that financed your mortgage.
Weigh alternative loan options. A cash-out refinance or home equity sharing agreement might be a better fit.
Know the credit score you’ll need
Credit scores count for a lot when determining your interest rate, and most lenders are looking for a score of at least 620. According to Experian, a score of 300-579 is considered poor; a score of 580-669 is fair; 670-739 is good; 740-799 is very good; and 800-850 is exceptional. The higher your rating is, the more likely you are to be approved for a home equity loan.
You can request free credit reports from the three major credit reporting bureaus (Experian, Equifax and TransUnion) using AnnualCreditReport.com. Check all three for any errors that may be suppressing your score, and dispute them using the online portal associated with that bureau. You’ll need to provide relevant documentation, which can include credit card statements, loan documents, bank statements, certificates, and any reports or complaints related to identity theft.
How to build your credit score
If you can afford to wait to take out a loan, building up your credit score will help you qualify with more lenders and get better rate offers. Some strategies to consider include:
Prioritizing paying all bills on time, and making payments on any accounts that are past due.
Keeping your credit cards open, but aiming to pay down any credit card balances so they are below 30% of your limit.
Reviewing your credit reports and disputing any errors.
Limiting applications for new loans or credit lines that will result in a hard credit inquiry.
Being wary of schemes that promise quick fixes. Instead, consider working with a credit counselor who can help you manage your debts.
Check your debt-to-income ratio
Qualified borrowers can get a home equity loan even with bad credit. That’s because you’re using your home to guarantee the loan. Lenders like having property as collateral, so they’ll work the "let’s get you approved" numbers a little harder.
Yet numbers still play a significant role. For example, to improve your chances of being approved and getting a lower interest rate, know your debt-to-income ratio. It’s what you owe divided by what you make. The NerdWallet DTI calculator can help you find your ratio.
A DTI of 43% or less will put you in the sweet spot for most lenders. But if you shop around, you can find lenders that allow higher DTIs (i.e., higher monthly debt).
It’s a balancing act between your credit score and your DTI. If you have a high DTI, it helps to have a higher credit score. A lower credit score might require a lower DTI. Ultimately, you have to be comfortable with your payment, and if your DTI is on the higher end, you may feel more stretched with money each month.
Find out how much home equity you have
Usually, you can borrow up to 80% — sometimes more — of the value in your home. It’s another lending metric called the loan-to-value ratio.
Here’s how it works.
Say your home's current market value is $300,000. You owe $200,000. Your LTV is 67%. If a lender allows you to borrow up to 80% LTV, you could pull $40,000 equity from your home:
$300,000 x 0.80 (80%) = $240,000 - $200,000 (what you still owe) = $40,000.
This home equity loan calculator will do the math for you.
The key factors here are what you owe and the current market value of your home. It’s easy to know how much you still owe on the house: You can always call your mortgage holder for the balance or view it in your online account. Knowing what your home is worth is another matter. NerdWallet account holders can use this home value estimator to get an idea.
A lender will require an appraisal to nail down the official market value.
Consider alternatives
Cash-out refinance
If you think you’re on the border of approval for a home equity loan, a cash-out refinance could be another option. This involves replacing your original mortgage with a larger one, allowing you to pocket the difference. Note that you’ll have a new rate and set of terms, which will affect your monthly payments if rates have increased since you bought your home.
It’s not a second mortgage, so lenders have even more leeway in underwriting the loan. You still have to have a good chunk of equity to make this work, but you may find it easier to qualify.
And make sure to shop for lenders to find your best refinance option.
Home equity sharing agreement
Another option to explore is a home equity sharing agreement, which allows you to access some of the equity in your home in exchange for giving an investment company a minor share of ownership in the property.
Home equity sharing agreements can have very low credit score thresholds. The investment company Point, for example, requires a minimum score of 500. While these loans can be easier to qualify for and don’t require monthly payments, they can also be much more expensive if the value of your home grows over the life of the loan. Because the investment company gets a percentage of the home’s value, the repayment can amount to tens of thousands of dollars more than the original loan amount. This comes due when the loan term ends (often after 10 years) or when the house is sold.
Personal loan
If you can’t qualify for a home equity loan, a personal loan may offer more flexibility when it comes to minimum requirements. NerdWallet’s roundup of the best bad credit loans highlights several options that serve borrowers with credit scores below 600. If possible, though, try to avoid lenders that charge high interest rates that will make it difficult to keep up with monthly payments.
