How to Get a Home Equity Loan With Bad Credit

Money’s main takeaways

• Home equity loans let you leverage the increase in your home’s value and use the proceeds for just about any purpose, from home renovations to consolidating high-interest debt.
• There are home equity and HELOC lenders who have credit score requirements in the 600s. However, you will pay a higher rate and likely be required to have at least 20% equity in your home.
• Your existing mortgage lender may approve you with a lower credit score if you have a history of on-time payments and a steady income.
• Checking your credit report for incorrect or outdated information, getting a cosigner, and reducing your DTI are all ways to improve your chances.

Read on to find out how you could qualify for a home equity loan, even with bad credit.

Table of Contents

• Home equity loans and HELOCs when you have bad credit
• How to qualify for a home equity loan with bad credit
• Home equity loan alternatives
• Summary of Money’s Home Equity Loan with Bad Credit

Home equity loans and HELOCs when you have bad credit

There are two main ways to leverage the equity you have in your home: home equity loans, sometimes called second mortgages, and home equity lines of credit (HELOCs). It is also possible to get a no appraisal home equity loan under certain circumstances.

Both of these options let homeowners borrow an amount equivalent to approximately 85% of their home's equity, but they do so in different ways.

While home equity loans provide you with a lump sum that you’ll pay back in installments over a set amount of time, HELOCs are a type of revolving credit. This means you can borrow up to a pre-established credit limit during its draw period, and that credit becomes available again as you pay back what you’ve borrowed. Once the draw period ends, the repayment period begins, and you will no longer be able to withdraw money.

It’s important to note that both loans present a big risk: since your home serves as collateral, the bank could foreclose on it if you fail to pay back the loan.

Both types of loans have similar requirements, and while it might be challenging to qualify for these with a bad credit score, it’s not impossible provided you meet other criteria.

For example, banks that cater to borrowers with low credit scores might require a higher income and therefore, a lower debt-to-income ratio. They might also ask for a greater percentage of equity in the home, and will place higher interest rates than they would on loans to borrowers with good credit.

Approval is not guaranteed

You should know that a poor credit history significantly reduces your chances of approval or will come at a higher cost in terms of stricter qualifying requirements that must be met and higher interest rates. If a home equity lender “guarantees” approval, it should raise a red flag and you should be extremely cautious about applying for a home equity loan with that lender.

Can you get a home equity loan with bad credit?

If your FICO score is between 620 and 700, could probably with some lenders, provided you have enough equity in your home and a high income.

Home equity lenders typically approve borrowers who have 15% to 20% equity in the home. If your score is lower than 700, however, they may require you to have at least 20%.

In addition to your credit score and equity, lenders will also consider your income and debt-to-income (DTI) ratio. This is the percentage of your monthly gross income that goes toward paying your existing debt.

Many lenders require a maximum DTI of 43%, although some might ask for a much lower percentage if you have a low credit score.

Can I get a HELOC with bad credit?

Much like home equity loans, most HELOC lenders require minimum credit scores in the 620 to 700 range, at least 15% to 20% equity in the home and a maximum DTI of 43%.

One thing to consider, however, is that, unlike fixed-interest-rate home equity loans, HELOCs typically feature variable interest rates. This could cause your payment to change over time, making it harder to budget for.

If you have bad credit and are applying for a HELOC, it’s important to remember that lenders will probably offer you their highest interest rates, which might become even higher over the life of the loan.

Requirements to get a home equity loan with bad credit

Lenders that issue bad credit home equity loans will likely require the following:

• A minimum credit score of 620
• 15% to 20% equity in the house
• Maximum DTI of 43%
• Be able to pay the loan origination fee and other closing costs

Qualifying for a loan will be difficult if you don't meet these requirements.

How to qualify for a home equity loan with bad credit

While it’s not easy to qualify for a home equity loan or a home equity line of credit if you have a low credit score, it's not impossible either. Here are some steps that could help you increase your chance of approval.

Step 1: Review your credit report

Examining your credit report carefully is an essential step before applying for any loan. Borrowers with high credit scores qualify for lower interest rates. Knowing exactly where you stand will help you focus on the mortgage lenders that accept lower scores.

But there’s another good reason to check your credit carefully. Credit reporting mistakes are more common than most people think, and it’s worth checking whether errors are dragging your score down.

You can get free credit reports weekly from Annualcreditreport.com, the only government-approved website that provides free reports from all three credit bureaus (Experian, TransUnion and Equifax). Once you have your reports, review them in detail, checking for any incorrect information or negative items that should no longer be reported.

If you find mistakes or outdated information in your payment history, you can dispute the items with collectors or bureaus and get them removed from your report. Alternatively, if you find extensive inaccuracies, you could engage the services of a credit repair company, which can dispute the items for you. If that's your case, check out our picks of the best credit repair companies to find the right one for you.

Finally, if all the negative items in your reports are correct — and your credit score is 620 or less — we recommend you wait until your personal finances improve before applying. Focus on lowering your credit utilization ratio by paying down any credit card debt and making sure you pay any loans (especially your first mortgage) on time. This could make a significant difference in your credit profile in the short term.

Step 2: Calculate your equity and loan-to-value ratio

To put it simply, equity refers to just how much of your home you own compared to what you still owe the bank. And, as we mentioned above, most banks will require you to have at least 15% to 20% equity in the home — maybe more if your credit is on the lower end of the minimum range required.

The first step in calculating your equity is to get your home professionally appraised. While you might be tempted to calculate the value of your home using a market value estimation website, this will never be as precise as a professional assessment.

Calculating your equity is simple enough: simply subtract your mortgage balance from your home’s current market value. Say you owe $150,000 on your mortgage note and your home’s current appraised value is $250,000:

$250,000 - $150,000 = $100,000

In this example, your equity in the home is $100,000. To find out whether this amount is enough to qualify (that is, more than 15% to 20%), you can divide the amount of your equity by the appraised value of the home and multiply that by 100:

($100,000 / $250,000) * 100 = 40%

In this example, you’d have more than enough of the equity percentage required by most banks.

Once you know your equity, you’ll get another important number: the loan-to-value ratio (LTV). The LTV is the opposite of your equity and shows just how much you still owe on the property — the higher your loan balance, the more reluctant banks will be to take on the risk of a loan. Most lenders look for LTVs of less than 80%, meaning that the borrower has at least 20% equity in the home.

Since home equity loans are second mortgages, lenders will also consider them and calculate your combined loan-to-value ratio (CLTV) when determining your total property debt obligation.

If you don’t have enough equity in your home to qualify, there are some things you can do before you apply. If your financial situation allows, you can switch to making biweekly payments on your mortgage instead of monthly payments. (In other words, pay half your monthly balance every two weeks.) Because you’ll end up making at least two extra payments a year, this will reduce your mortgage balance — and thereby increase your equity — quicker.

You can also prioritize projects that speed up your home’s appreciation, that is, its gained value. According to many real estate experts, home improvement projects like kitchen and bathroom upgrades can quickly increase a home’s value.

Step 3: Calculate your DTI (and reduce it if possible)

The debt-to-income (DTI) ratio is an indicator of how much of your income is already going towards paying existing debt. Banks use this percentage to gauge whether you can afford another loan payment.

You can calculate your DTI by dividing your monthly debt — such as student loans, personal loans, credit cards, auto loans, rent or mortgage payments, etc. — by the amount you earn before taxes are deducted (your gross income).

For example, let’s say your gross monthly income is $4,000, and $1,400 of that goes toward debt payments. You’ll divide those amounts and then multiply the result by 100 to get a percentage:

($1,400 / $4,000) * 100 = 35%

Different lenders have different DTI ratio requirements; however, many look for a number around 35% or less, and will not approve anything over 43%. If your number is higher than that, it’s a good idea to work on reducing the ratio by paying down current installment loans before applying for a home equity loan or line of credit.

Also, take note that DTI does not consider daily expenses such as utilities, phone bills, child care and groceries. Remember to add in these expenses when determining if you can afford a new payment.

Step 4: Find a lender that accepts lower credit scores

The first step in finding a lender is to contact your current mortgage company since borrowers often face better odds with banks they already do business with.

However, if your current lender turns you down, there are other alternatives. There are plenty of great lenders that will consider applicants with credit scores in the mid-to low-600s.

Many of these are featured in our list of the Best Home Equity Loans, which includes:

Step 5: Use a co-signer

If your credit score is below what most lenders will consider, and you have someone willing to share responsibility, asking them to be a co-signer on your loan might be a good choice.

Also called a co-applicant or co-borrower, this person would be responsible for repaying the loan if, for some reason, you could not. This reduces the risk of default for the bank, which makes them more willing to approve the loan. To improve your chances of qualifying, your co-signer should have a stable income and a fair to excellent credit score.

For many borrowers with poor credit, getting a co-signer with a higher credit score can be the key to approval and/or better interest rates.

Pros and cons of a home equity loan

Borrowing money through a home equity loan has pros and cons.

Home equity loan alternatives

If you’ve decided that home equity loans or lines of credit aren’t the right choices for you, there are other loan options to consider.

Home equity sharing

Home equity sharing is a fairly new option in the home equity market. It’s a type of investment deal in which a borrower lets a company buy a portion of the equity in their home in addition to future changes to the equity. In this type of arrangement, the homeowner pays the funds back as a lump sum when the term of the contract ends, they sell the home or buy out the investor.

Cash-out refinance

Cash-out refinancing involves replacing your existing mortgage with a new one for a larger loan amount. The lender pays off the old mortgage and gives you the surplus as cash. This means you’ll start over again with a new loan with different loan terms and interest rates.

Do note that the Federal Reserve has recently increased rates, which will affect the kinds of interest rates banks and credit unions will offer. To check whether this is the right time to refinance, read our article on current mortgage rates. Additionally, learn more about the steps involved in refinancing your mortgage in this high-interest rate environment.

And, if you’re interested in this option, make sure to check out Money’s best mortgage refinance companies.

If you are interested in home equity sharing, check out our best home equity sharing companies.

Personal loans

Unlike home equity loans and lines of credit, personal loans are unsecured loans — in other words, they do not require collateral. This means that you won’t lose valuable assets (like your home) if you default.

However, because they’re unsecured loans, they’re harder to qualify for when you have poor credit, as banks might not be willing to take the risk unless you offer a valuable asset as a guarantee.

But if you qualify for an unsecured loan like this one, personal loans are good options, especially if you want to borrow smaller amounts and need the money fast.

Reverse mortgage

A reverse mortgage is a type of mortgage that lets homeowners 62 and older borrow a lump sum of money, open a line of credit or receive monthly payments while using their home as collateral. Unlike a regular mortgage, borrowers don't have to make monthly payments to the lender. However, the amount they owe increases, not decreases, over time.

Reverse mortgages are repaid once the owner (and their spouse, if they’re co-borrowers) moves out of the home for over a year. If the owner dies before moving out, their heirs will have to decide whether to sell the home, repay the loan or surrender the title to the lender.

Our article, Reverse Mortgage Pros and Cons, has important information every homeowner needs to know before applying for this kind of mortgage.

Summary of Money’s How to Get a Home Equity Loan with Bad Credit

• While it might be challenging to qualify for a home equity loan or line of credit when you have bad credit, there are steps you can take to increase your chances of approval.

• Most mortgage lenders have minimum credit requirements of anywhere between 620 and 700.

• These types of loans use the equity in your home as collateral, meaning there’s a risk of foreclosure if you default on the loan.

• Lenders also require a certain amount of equity in your home — typically at least 15% to 20%, but this might be higher for borrowers with bad credit.

• Bad credit home equity loans typically have stricter approval requirements in other areas, such as a greater percentage of equity and/or higher income.

• Some popular alternatives to home equity loans and lines of credit are home equity sharing, cash-out refinancing, personal loans, debt consolidation loans and reverse mortgages.