How to Get a Home Equity Loan With Bad Credit

Steps to get a home equity loan with bad credit

Here are the steps you can take to strengthen your position when applying for a home equity loan, even if your credit isn’t perfect.

1. Review your current mortgage and financial documents

Start by gathering all relevant financial documents, including your mortgage statement, pay stubs, tax returns, and bank statements. This helps you understand your current financial standing and provides the necessary paperwork lenders will require during the application process.

2. Check your credit report

Obtain a copy of your credit report from the major credit bureaus to review it for errors or inaccuracies. Correcting any mistakes can improve your credit score, potentially making you a more attractive candidate to lenders.

3. Determine your debt-to-income ratio (DTI)

Find your DTI by dividing your total monthly debt payments by your gross monthly income. Knowing your DTI helps you understand how much additional debt you can handle. Lenders use this ratio to assess your ability to repay the loan, so a lower DTI can enhance your approval odds.

4. Establish your home’s value and calculate your equity

Research your home’s current market value. You can get a preliminary value using a free online Home Value Estimator tool. You can also compare recent sales of similar homes in your area or get a professional appraisal. Subtract your outstanding mortgage balance to find your equity. The more equity you have, the more likely a lender will consider your application.

5. Calculate your loan-to-value ratio (LTV)

Divide your current mortgage balance by your home’s appraised value to estimate your LTV. A lower LTV ratio indicates you have more equity, which can offset a lower credit score and make lenders more willing to approve your loan.

6. Contact a lender you already work with

Reach out to your current mortgage lender or bank, as they already have a history with you. They might be more flexible in working with you despite your credit score, especially if you’ve maintained a good payment history with them.

7. Petition multiple lenders with letters of explanation

Approach several lenders to compare terms and interest rates. Include letters of explanation for any negative marks on your credit report, such as job loss or medical expenses. Providing context can help lenders understand your situation and potentially offer more favorable terms.

8. Consider your co-signer options

If your credit score is a significant barrier, think about asking a trusted family member or friend with good credit to co-sign the loan. A co-signer can provide the added security a lender needs to approve your loan, though this means they’ll be responsible if you default.

As you shop for a loan, look for lenders that specialize in helping borrowers with lower-than-average credit scores*. A few examples include:

• TD Bank: 660 minimum credit score
• Fifth Third Bank: 660 minimum credit score
• Connexus Credit Union: 640 minimum credit score
• Spring EQ: 640 minimum credit score
• Discover: 620 minimum credit score

*Minimum credit score requirements can vary with loan types and change over time. Check lender websites for current minimums and required LTV/DTI ratios.

You may find you have better luck with a lender offering a home equity line of credit (HELOC) rather than a traditional home equity loan. HELOCs let you use your home equity as a secured credit line similar to a credit card. They typically have a withdrawal period, followed by a repayment phase of 10, 15, or 30 years. HELOC interest rates are usually similar to home equity loan rates.

How to improve your loan approval odds

Now, let’s look at some actions that can improve your credit score and show lenders you’re serious about managing your finances, increasing your chances of loan approval.

• Pay bills on time: Timely payments can boost your credit score over time, demonstrating financial responsibility to lenders.
• Pay down credit card balances: Reducing your credit card debt lowers your credit utilization ratio, which is a significant factor in your credit score.
• Keep your credit card accounts open: Closing accounts can negatively impact your credit utilization and reduce the average age of your credit history. Keeping them open can help maintain or improve your score.
• Avoid new loans and credit cards: Applying for new credit can result in hard inquiries, which can temporarily lower your credit score. It’s best to avoid this when you’re planning to apply for a loan.
• Ask for a credit limit increase: Increasing your credit limit can also lower your credit utilization ratio, improving your credit score. Just be sure not to rack up more debt as a result.
• Increase your income: Taking on a side job or finding ways to increase your income can help improve your debt-to-income ratio, making you a more attractive candidate for lenders.
• Refinance high-interest loans: Refinancing to lower interest rates can decrease your monthly payments, improving your DTI ratio and leaving more room for a new loan.
• Review your credit reports and dispute errors: Look for any inaccuracies on your credit report and dispute them with the credit bureau. Removing errors can improve your credit score.
• Consolidate debt: Debt consolidation can simplify your finances and potentially reduce interest rates, making it easier to manage and pay off debt and improving your financial profile.

Another tip is to get a secured credit card and make certain you pay it off consistently each month. A secured credit card is a type of credit card that requires a cash deposit as collateral when opening the account. The deposit is usually equal to the card’s credit limit and is refundable. While secured cards function a little differently than typical credit cards, the payment history is reported to credit bureaus, which can help improve your credit score.

Red flags of quick-fix services and schemes

Beware of groups or companies that tell you they can fix your credit for a fee. While there are legitimate services available to help consumers lower debt burdens and improve credit scores, there are also outfits that will take advantage of your circumstances.

Below is a list of red flags you can watch for to better protect yourself from scams and predatory lenders

• Promises that sound too good to be true: Be wary of services that guarantee loan approval regardless of your credit score. Legitimate lenders assess your financial situation carefully before offering a loan.
• Extremely high interest rates: Predatory lenders often charge exorbitant interest rates, trapping you in a cycle of debt. Always compare rates with reputable lenders before making a decision.
• Large, unexplained upfront fees: Legitimate lenders may charge application or origination fees, but excessive or vague upfront fees are a red flag. Always ask for a detailed breakdown of any fees.
• Low initial payments with a “balloon payment” at the end: Loans with low initial payments and a large final payment can be risky if you’re not prepared. Ensure you understand the loan terms before committing.
• Pressure to quickly sign a contract: If a lender pressures you to sign quickly without giving you time to read and understand the contract, walk away. Legitimate lenders will allow you to review the terms carefully.

Home equity loan alternatives

If you need borrowed funds and have not had success with any of the steps or tips we’ve provided above, you may need to find an alternative. Below is a list of options that might help you find another financial solution for your situation:

• Personal loans: Unsecured personal loans can be an option if you need funds but have poor credit. While interest rates may be higher than a home equity loan, you won’t risk losing your home.
• Cash-out refinance: This option allows you to refinance your mortgage for more than you owe, taking the difference in cash. It can be a good choice if you can secure a lower interest rate than your existing mortgage.
• Reverse mortgage: If you’re 62 or older, a reverse mortgage lets you convert part of your home equity into cash. Keep in mind, it comes with specific requirements and potential downsides.
• Home equity investment agreement: This involves selling a portion of your future home appreciation to an investor in exchange for cash now. It’s not a loan, so there are no monthly payments, but you’ll share future gains with the investor.
• Credit card: While using a credit card isn’t ideal due to potentially high interest rates, it can be a short-term solution for smaller expenses. Just be cautious of accumulating more debt.
• Borrow from a trusted family member or friend: If possible, borrowing from someone you trust can be an alternative to a formal loan. It’s important to agree on terms and put everything in writing to avoid misunderstandings.

Using your home’s equity to buy before you sell

If you’re borrowing plans involve using your home’s equity to purchase your next home, HomeLight’s Buy Before You Sell program can simplify the entire process. This modern solution allows you to unlock your equity to make a strong offer on your new home while avoiding the headache of timing the sale of your current home.

If you and your property qualify, this innovative program can give you the financial flexibility to move only once and on your own schedule, streamlining the transition to your new home. Here’s a 60-second look at how HomeLight Buy Before You Sell works:

Next steps if your home equity loan is denied

If you are a homeowner with poor credit, taking steps to lower your DTI and LTV ratios can improve your chances of getting approved for a home equity loan. This process can include reducing your other debts, adding to your monthly income, and growing your home’s value.

If you are just stepping into this process, keep in mind that moving the needle on your credit score can take time. Be vigilant, but also be patient. Securing a home equity loan with bad credit is challenging but possible with the right approach.

Header Image Source: (Clay Banks / Unsplash)