How to Qualify for a Home Equity Loan with Bad Credit

 In Home Equity

When looking into options for financing in a pinch, your house is probably the biggest asset you own.

If you’re pressed for cash, you may be able to borrow some funds against your property. When you do so, you’re seeking what’s called a home equity loan.

Banks are more likely to grant home equity loans to recipients who have excellent credit. If a history of late payments or loan defaults has left you with a lower credit score, you may still have options. In this guide, we’ll address how to qualify for a home equity loan with bad credit.

First, why should I get a home equity loan?

You may hear the terms home equity loan and home equity line of credit (HELOC) thrown around together. They’re similar in that they allow you to borrow money against your home. However, the former provides you with a lump sum of cash, while the latter lets you draw money as you need it.

Homeowners are often drawn to home equity loans because these loans allow homeowners to borrow large amounts of money that might otherwise be difficult to obtain with credit cards or personal loans. Homeowners might use these lump sums to consolidate debt or pay off unexpected life expenses.

But banks and other large financial institutions are hesitant to give loans to borrowers with lower credit scores because they consider those borrowers to be a risky investment. But it’s still possible to qualify for a home equity loan with bad credit.

4 Steps to Take to Qualify for a Home Equity Loan

Before applying for a home equity loan, there are four steps you need to take to maximize your chances of getting the funds you need. 

1. Figure Out Your Debt-to-Income Ratio

Lenders love home equity loans because they come with valuable collateral—your residence. The physical asset backing their loan gives them peace of mind to let you borrow money, even if your credit score is low.

Your debt-to-income ratio is an important figure that lenders will be looking at to determine eligibility. This figure is what you owe divided by how much money you bring in. 

Most lenders want homeowners to have a DTI value in the low 40% area. If you have other debts to pay off, like car or student loans, your DTI will go up.

If you have a low DTI but a bad credit score, you’ll have a better chance of receiving a home equity loan than the inverse. A high DTI looks worse even when stacked against a good credit score. 

2. Determine How Much Home Equity You Have

Your home likely has gone up in value, as home prices tend to rise over time (accounting for some dips due to financial crises and unforeseen market conditions). Did you know you can borrow up to 80% (even 90% in some cases) of your home’s value via a home equity loan? We refer to this metric as the loan-to-value ratio.  

If you’re not sure of the exact amount you currently owe, you can contact your bank to find out. If you decide to seek a home equity loan, your bank will send someone out to appraise your home and determine the official market value. You will need an official appraisal for this processballpark values provided by property websites such as Zillow may not be accurate.

3. Understand the Credit Score You’ll Need

In 2021, Americans were reported to have an average credit score of 711. If you find your own credit score falls below this national average, there is still hope. Most lenders only require home equity loan seekers to have a FICO score of 620 or higher. 

If you fall below the 620 figure, you don’t have to count a home equity loan out completely. Your lender might be willing to work with you—but prepare yourself for a higher interest rate.

In the meantime, there are also ways to raise your credit score. Here are some tips:

  • Prioritize making payments on time (and catch up on any missed payments)
  • Don’t apply for any new lines of credit (too many hard inquiries can damage your credit over time)
  • Consolidate your debt (to avoid having too much revolving debt)

If you’re having trouble managing payments, call your lenders to ask about your options. Some will be able to move payment due dates slightly or extend the length of your loan to allow you to make smaller payments.

4. Consider a Cash-Out Refinance

A cash-out refinance involves refinancing your current mortgage and taking out cash based on your home equity—it’s like a combination of refinancing and a home equity loan.

This may be an option for homeowners who also want to lower their interest rate in order to save money in the long term. To refinance, most lenders typically require a credit score of at least 580, but this will vary from institution to institution.

Contact Our Team at Associates Home Loan Today

Your low credit score doesn’t need to hold you back from your goals. Here at Associates Home Loan, we specialize in getting loans to homeowners who need them—and we’re here to help you next. 

To learn more, contact the experts at Associates Home Loan today. We’ll help you find an option that works best for you and your family.

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