How to get a home equity loan with bad credit
In this high inflationary environment, many people are struggling to manage their expenses. Things like gas, groceries and childcare can quickly add up. Add in any variable debt that you might have, such as from carrying a credit card balance, and it can be tough to make ends meet.
While you don't want to necessarily dig yourself a deeper hole, some homeowners find that borrowing against their home equity provides them with the breathing room they need.
Perhaps you've improved your spending habits and are comfortable taking on new debt, but decisions you made when you were younger are catching up to you. If you can pay off higher-interest debt with a home equity loan or HELOC, for example, then you might save money on interest payments.
But if you have bad credit, can you still qualify for a home equity loan? It depends on what your credit report looks like and the lender's requirements.
That said, you often need a credit score of at least 680 to get a home equity loan. Some lenders will go below that number, but in general, the lower your credit score, the harder it will be to find a lender and get favorable terms.
However, there are steps you can take to improve your chances to qualify for a home equity loan and find more favorable terms. If you think a home equity loan could be advantageous for your personal financial situation then start exploring your options.
How to get a home equity loan with bad credit
Here are five ways to improve your chances of getting a home equity loan with bad credit.
Review credit reports for errors
Your credit score might be lower than it should be based on errors on your credit report. A Federal Trade Commission (FTC) study found that around 5% of people have had a more than 25-point credit score change by correcting credit report errors, so it makes sense to check and dispute errors, which you can do for free. The FTC advises consumers to check their credit reports for free from each of the three big credit bureaus once every 12 months via AnnualCreditReport.com.
Perhaps you paid off a balance that is still showing as unpaid on your credit report. Or maybe you never opened an account that's showing up on your credit report, which could be a sign of identity theft that you'd want to correct before it causes more damage.
Make sure you have enough equity
If you're trying to take out a home equity loan that, when combined with your mortgage balance, leaves you with very little equity in your home, that could make interest rates higher. And if you're struggling with your credit score, that makes it even harder to get good terms.
So, talk to lenders about how different combined loan-to-value (CLTV) ratios affect interest rates. Many lenders will go to around 85% CLTV, but perhaps if you took out a home equity loan at a lower ratio, you'd get better terms. Or maybe you're trying to qualify at a 90% CLTV, but the lender would only do that for a borrower with a higher credit score.
In that case, you might wait to take out a home equity loan until, say, real estate conditions potentially improve to the point where your home's value gives you more equity.
You can check your home equity loan eligibility here now.
Stop activities that can lower your score further
In addition to addressing issues like credit report errors and fraud, you can also improve your credit score by stopping activities that have a damaging effect.
For example, having a high credit utilization ratio, such as from maxing out your credit cards each month, can hurt your credit score. A rule of thumb is to keep your credit utilization ratio below 30%, but ideally, you want to be in the range of 1-9%, says Experian.
So, if your credit limit for a credit card is $10,000, you might limit your spending on that card to $100-900 per statement and pay that off each month. Keep in mind that your credit utilization applies to specific accounts as well as your overall borrowing.
With time, better habits can improve your credit score.
Lower your debt-to-income ratio
Another way to improve your chances to qualify for a home equity loan with bad credit, especially without paying ultra-high interest rates, is to lower your debt-to-income (DTI) ratio.
For this area, the rule of thumb is that you want your debts to add up to a maximum of 43% of your income. But perhaps getting significantly lower than that limit would make a lender more willing to work with you even if you have bad credit.
How can you lower your DTI ratio?
Suppose your household has two cars, each with a car loan. Yet maybe you and your spouse both work from home and you don't necessarily need two cars anymore. In that case, maybe you could sell your car and eliminate that debt, thereby lowering your debt-to-income ratio.
Shop around
Lastly, if you have bad credit, don't assume that if one lender refuses you then all will. Different lenders have different requirements, so shop around and see who's willing to work with you and what their terms are.
Even if you don't qualify yet for a home equity loan, you can get a better sense of what you need to aim for by shopping around. Perhaps you can find a lender that has a minimum credit score requirement that you think you can reach in a few months, and having that benchmark could be the motivation you need to get there. You can shop around for home equity loan lenders here.
The bottom line
Overall, having bad credit can make it more challenging to get a home equity loan, but it's not impossible. You might need some patience to find a lender and/or improve your credit score, but you probably don't want to rush into this decision anyway.
If you made hasty borrowing decisions in the past that dropped your credit score, for example, then you probably wouldn't want to make that mistake again, especially because you'd be putting your home at risk of foreclosure if you don't pay back the loan.
But if you're confident that you're on solid financial footing and can manage a home equity loan, then it can make sense to search for a lender that will work with your credit situation.
