Home equity loans and lines of credit -- HELOCs -- are popular among homeowners looking for quick access to cash at a lower interest rate than other financing options, such as cash-out refinances and personal loans. But as with any loan, your credit score will impact your eligibility as well as the terms and conditions of the loan.
Some banks and lenders will approve you for a home equity loan or HELOC even if you have poor credit, because your house serves as collateral for the loan. However, you can expect to have a higher interest rate.
Here’s what you need to know about how to qualify for a home equity loan and HELOC if you have bad credit.
How to qualify for a home loan with bad credit
Not all lenders operate by one standard set of credit guidelines, so it’s important to shop around, but keep in mind the more common requirements to qualify for a home equity loan or HELOC. Although requirements vary, most lenders want to see a minimum credit score in the mid-600 range and a sizable percentage of equity in your home (usually 15% to 20%).
Your credit score isn’t the only thing lenders consider when approving you for a home loan. The amount of equity in your home, your loan-to-value ratio and current debt level all play a role. However, your credit score is a critical part in determining the interest rate your lender will charge you. Even if you have a score that is considered good under FICO rules -- 670 to 739 -- you’ll have to pay a higher interest rate than someone with exceptional credit, which is 800 to 850.
Common requirements for a home equity loan and a HELOC
- You must have at least 15% to 20% equity in your home
- A minimum credit score of 670 (which will vary by lender)
- A maximum debt-to-income ratio of 43% (although some lenders will accept as high as 50%)
- A verifiable income and consistent employment
- A history of on-time bill payments
Which lenders will approve you with bad credit?
If you have bad credit, expect to pay higher lender fees and have less flexible borrowing options available to you. Here are seven lenders who offer amenable terms for those who have less than stellar credit.
Lenders to consider for bad credit
|Minimum credit score
|Up to $150,000
|Starting at 6.24%
|Fifth Third Bank
|$10,000 to $500,000
|7.22% to 14.15%
|$15,000 to $400,000
|$10,000 to $1 million
|7.99% to 21%
|$25,000 to $400,000
|Starting at 7.24%
|640 for home equity loans, 680 for HELOCs
|$25,000 to $500,000
|Third Federal Savings & Loan
|$10,000 to $200,000
|Starting at 6.74%
Discover: For home equity loans only; doesn’t offer HELOCs to homeowners with bad credit.
Fifth Third Bank: Only available for borrowers in Florida, Georgia, Illinois, Indiana, Kentucky, Michigan, North Carolina, Ohio, South Carolina, Tennessee and West Virginia.
Figure: Only offers HELOCs.
Flagstar Bank: Good for homeowners who need high loan amounts and don’t want to pay closing costs. Home equity loans are only available through a physical branch.
Rockland Trust: Only available in the New England area.
Spring EQ: Ideal for homeowners who want a longer repayment period.
Third Federal Savings & Loan: Ideal for those who need a long repayment period and want the option to choose a fixed-rate or variable-rate loan.
How to apply with bad credit
Here are the steps to take to apply for a home equity loan if you don’t have good credit.
1. Review your credit report
Your credit is one of the first factors lenders will look at when determining your eligibility for a home loan. It’s important to monitor your credit regularly to make sure it’s accurate and up to date. The last thing you want are surprises on your report, such as past negative hits that have since been resolved but haven’t been corrected on your credit report that still make you seem like a risky borrower. You can receive a free weekly credit report through the end of this year by visiting AnnualCreditReport.com. Also, set up alerts that notify you the moment your credit score drops.
2. Calculate your debt-to-income ratio
Your debt-to-income ratio, or DTI ratio, is the total of all of your monthly debt payments divided by your gross income. You can use a DTI calculator to determine yours or do the calculation below.
Monthly debt payments / monthly gross income = DTI ratio
For example, if you earn $6,000 a month and have $1,500 a month in debt payments (be it credit cards, student loans, a car loan or all of the above), the calculation for your DTI is simply:
$1,500 (monthly debt payments) / $6,000 (monthly gross income) = 0.25, or 25% DTI
That 25% is certainly within the limit for lenders. Although a DTI of 43% is the highest ratio many banks are willing to consider (with a few accepting as high as 50%), they prefer that a borrower has a DTI ratio no higher than 36%.
3. Make sure you have enough equity
Having enough equity in your home is critical to securing a home loan with bad credit. Without enough equity, a lender won’t approve you regardless of your credit score or income. Most lenders typically want to see 15% to 20% at a minimum. The more equity you have built up, the more attractive a candidate you are for a loan with better terms.
While not required, you’ll want to consider working with the lender that originated your first mortgage, as you already have a relationship and your lender knows you’ve been making on-time, consistent mortgage payments over the years.
You can also use a home equity calculator to figure out if you have enough equity to qualify for a loan.
4. Determine how much you need
Even if a lender approves you for a higher loan amount than you need, you don’t want to take out more than you’re able to pay back. The way that lenders determine how much you can borrow is by assessing your loan-to-value ratio, or LTV ratio. Your LTV is your outstanding mortgage balance divided by your home’s current value. If, for example, your house is valued at $500,000 and you have $150,000 left to pay on your mortgage the calculation is:
$150,000 / $500,000 = 0.70, or 70% LTV
A lender will usually let you borrow between 75% and 90% of your available home equity. To figure out that amount, use the following calculation:
[Current appraised value] x [maximum equity percentage you can borrow] – [outstanding mortgage balance] = The amount a lender will let you borrow
In this example, a lender is willing to let an applicant borrow up to 85% of their home equity:
$500,000 [current appraised value] x 0.85 [maximum equity percentage you can borrow] – $350,000 [outstanding mortgage balance] = $75,000 [what the lender will let you borrow]
Another important ratio is your combined loan-to-value, or CLTV, ratio, which is the ratio of all outstanding loans secured against your property divided by your home’s current value. Most lenders want to see a CLTV of 85% or less.
5. Compare interest rates
The interest rate is another critical component used when calculating your loan because even one tenth of a percentage point can add thousands of dollars to your mortgage over the years. Take the time to compare and review interest rates.
6. Use a cosigner
Consider asking a family member or friend to co-sign your loan provided they have a solid credit history and financial history. With a co-signer, the bank is willing to lend you the money because the co-signer is on the hook for your loan payments if you fall behind for any reason. If you can’t make your payments, your co-signer has to make them for you.
Make sure you and your co-signer are comfortable with agreeing to such a serious, long-term financial arrangement. Also, be certain your co-signer understands that their credit score is on the line, as it will drop if you miss payments.
7. Try boosting your credit first
It may be worth delaying your loan application until you can improve your credit. That’s because securing the lowest interest rate possible and minimizing fees will save you tens of thousands of dollars over the lifetime of your loan. You’ll also have access to more loan options with more favorable terms, such as higher borrowing limits, if you raise your credit score before applying.
Alternative financing options
You can apply for other types of loans if you have bad credit, but you’ll likely have to pay much higher interest rates and the amount you can borrow will be limited.
- Personal loan: A personal loan isn’t secured by your home, so banks will charge you higher interest rates to borrow the money. The average rate for a personal loan is currently 10.71% according to CNET’s sister site Bankrate. But if you have bad credit you should expect to pay a much higher rate. Personal loans also usually have shorter repayment terms than home equity loans.
- Cash-out refinance: A cash-out refi replaces your current mortgage with a new one, but with a lower interest rate and terms. However, it won’t make sense for most homeowners right now as mortgage rates are at their highest level in 20 years, canceling out the benefit of refinancing to a lower rate.
- Reverse mortgage: A reverse mortgage is only available to homeowners ages 62 and older -- the benefit is that you don’t have to make monthly mortgage payments and the bank or lender actually makes monthly payments to you. You have to continue paying your property taxes and homeowners insurance and use the house as your primary residence to qualify.
If you get approved, keep improving your credit
It’s wise to repair your credit regardless of what condition it’s in, but it’s especially helpful when applying for a home loan. Focus on strategically paying down your credit card balances -- start with the cards that have the highest interest rates and the highest balances. You can also work with a credit repair agency, but make sure you’re working with a reputable company or nonprofit, and be aware of common scams to avoid.