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A home equity loan can be a great low-cost way to borrow money to finance home renovations or consolidate debt. But if you have bad credit (FICO score below 580), you might have a hard time getting approved.
Getting a home equity loan with bad credit is not impossible, however. Here’s how.
4 tips to increase your chances of approval
1. Check your credit score
Before applying for a home equity loan, it’s a good idea to find out where your credit currently stands. Free sites such as Credit Karma provide educational credit scores, which can be helpful in getting a rough idea of your current credit score. However, most lenders rely on your FICO credit score, which sometimes requires payment to see the score, although some credit card companies allow customers to get their FICO scores for free.
Most lenders require a score of at least 680 in order to get approved for a home equity loan. This is considered a “good” score. However, you may still qualify for a home equity loan with bad credit. Since home equity loans are secured by your property, meaning your home acts as collateral if you fail to repay the loan, there is less risk for the lender. And it can help if your other financial qualifications are strong.
2. Calculate your monthly debt ratio
Your debt-to-income ratio (DTI) is one of the most important factors lenders consider when approving you for a mortgage. This number measures how much of your gross monthly income is used to pay your debts, expressed as a percentage. For example, if you earned $6,000 per month before taxes and paid $2,100 per month for your student loan, car, and credit card payments, your DTI would be 35%.
Lenders prefer to see a DTI of 43% or less, although some may accept up to 50% in some cases. However, if you have bad credit, you will need a low enough DTI to qualify for a home equity loan.
3. Check your home equity
You also need to have enough equity in your home, especially if you’re trying to get a home equity loan with bad credit. Lenders use what is called a Loan to Value (LTV) ratio which divides your current mortgage balance by the current appraised value of your home. For example, if your home is worth $300,000 and you still owe $240,000 on your mortgage, your mortgage is 80% ($240,000/$300,000). This means you have 20% equity in your home.
Typically, lenders require you to have an LTV of 80% or less in order to borrow a home equity loan. To find out the current value of your home, you will need to have it appraised, which usually costs a few hundred dollars.
4. Find a co-signer
Another way to increase your chances of getting a home equity loan for bad credit is to hire a co-signer. This means that a trusted family member or friend with good credit essentially vouches for you as a borrower and agrees to repay your loan if you can’t.
Before going this route, it is important to understand the risks. If you miss your loan payments, your co-signer’s credit may suffer, as well as yours. And if you don’t make your payments, the co-signer becomes legally responsible for the debt. Of course, the hope is that you would never find yourself in this situation. But if you do, it can harm your relationship as well as both your credit ratings.
How to find lenders willing to work with bad credit
If you have bad credit, it can be difficult to find lenders willing to give you a loan. It’s important to shop around and get quotes from multiple lenders, especially since the interest rate will be higher and getting the lowest rate possible will save you a lot of money in the long run. Some places to watch include:
- Local banks and credit unions. Community banks and credit unions may have more flexibility with their underwriting standards than larger banks, especially if you are already a customer there. They also need to be more competitive to attract business and may be willing to take on riskier loans.
- Online lenders. Since there is little overhead compared to a physical bank, online lenders can pass these savings on to their customers in the form of lower interest rates and fees. Plus, it’s easy to get quotes online without a credit check, so you can get multiple offers to compare in minutes.
Once approved, continue to improve your credit
If you’re able to get a home equity loan despite your bad credit, congratulations. But you shouldn’t stop there. One day, you might want to take out another loan, refinance your mortgage, or open up a lucrative rewards card — and having good credit will make that much easier.
You can start by picking up a free copy of your credit reports from each of the major bureaus (Equifax, Experian, and TransUnion) at AnnualCreditReport.com and examine them for any issues. For example, you may find an error, which may lower your score. If you find an error, be sure to dispute it with the bureau reporting it, as it can take weeks to be corrected on your credit report.
It’s also a good idea to look for any negative marks that could be easily fixed, such as a credit card that’s maxed out or a bill that’s been sent to collections. Taking the time to address these issues will help your score improve faster.
Other financing options
If you’re having trouble qualifying for a home equity loan with bad credit, you may want to consider other financing options. You have a few alternatives:
- Refinancing by collection. Another option is to refinance your current mortgage with a new loan for a larger amount and pocket the difference. This is similar to a home equity loan, as you still need to have at least 20% equity to qualify and your home serves as collateral for the loan. However, if you’re able to refinance at a lower rate than you’re currently paying, it could be a good deal.
- Personal loan. If you’d rather not take out a loan secured by your home, consider a personal loan instead. Unsecured personal loans allow you to borrow money without collateral. As a result, however, you will pay a higher interest rate, especially with damaged credit. In fact, personal loan rates can be as high as 36%. Securing your loan with an asset, like a bank account or a vehicle, can lower your rate.
- Reverse Mortgage. If you’re 62 or older, you may be able to leverage the equity in your home in the form of a reverse mortgage. Rather than repaying the loan in monthly installments, you receive either a lump sum, monthly installments, or a line of credit. Interest is added to your loan balance and does not need to be paid until you move or die. In most cases, the house is then sold and the proceeds are used to pay off the balance.
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