Can You Get a Home Equity Loan With Bad Credit?

What Is a Home Equity Loan?

Home equity is how much of your home you currently own. It's calculated by subtracting what you owe on your primary mortgage and any other home loans from your property's market value. So, if your home is worth $400,000 and your outstanding loan balance is $250,000, your equity is $150,000.

Home equity loans typically allow you to borrow up to 80% to 85% of your combined loan-to-value (CLTV). That's your outstanding loan balance and home equity loan combined, divided by your home's value. In the example above, that works out to a borrowing amount between $70,000 and $90,000. You'll receive the money in one lump sum and repay it in fixed monthly payments during your repayment term, which typically ranges from five to 30 years.

Remember, a home equity loan is considered a second mortgage that uses your home as collateral. If you fall behind on payments and default on the loan, your lender could foreclose on your home.

Learn more: How Does a Home Equity Loan Work?

Can You Get a Home Equity Loan With Bad Credit?

You could still qualify for a home equity loan with less-than-ideal credit. Lenders may be more willing to accept a lower credit score if you're stronger in other areas, such as having a solid income and a low debt-to-income ratio (DTI). Most lenders look for a minimum credit score of at least 680, while more lenient ones may accept a score as low as 620.

Financial institutions typically don't approve borrowers with credit in the poor range (a FICO^® Score below 580). As a general rule, the higher your credit score, the greater the loan amount and the better the terms you may qualify for. If your credit score could be better, consider improving it before applying. Even a modest credit improvement from the upper fair range (580 to 669) into the good credit range (670 to 739) may lead to a substantially lower rate.

Example: Say you borrow $50,000 with a 15-year home equity loan. At a 7.5% interest rate, your monthly payment would be approximately $464, with total interest of $33,431. At 9.5%, the payment rises to $522 and total interest to $43,980, adding $10,549 in interest costs over the life of the loan.

Other Home Equity Loan Requirements

Besides meeting a lender's minimum credit score criteria, you'll need to meet other eligibility requirements similar to those for your primary mortgage.

• Sufficient home equity: Home equity lenders may allow a CLTV ratio of up to 85% or even higher. This ratio compares the amount of your mortgage and any other loans tied to your home, including the proposed home equity loan, with your home's appraised value. Your lender will likely require a home appraisal to ensure there's adequate equity to secure the loan.
• Proof of income: Lenders want to see that you have a steady job and enough income to afford the new loan payments. Be prepared to provide W-2s, recent pay stubs or other proof of income.
• Low DTI: Lenders pay close attention to your debt-to-income ratio (DTI) because it shows how much of your gross monthly income already goes toward your monthly debts. A low DTI shows lenders you're likely to manage the new debt responsibly. Most lenders require a DTI ratio of 43% or less.
• Strong payment history: Your payment history is included in your credit score, but your lender will still review it closely. You're more likely to get approved if you consistently make on-time payments on all your accounts.
• Proof of insurance: Just as auto lenders require you to carry car insurance to finance a new vehicle, home equity lenders want proof of homeowners insurance to protect their investment against loss if your property suffers major damage.

Learn more: Requirements for a Home Equity Loan or HELOC

Pros and Cons of Getting a Home Equity Loan With Bad Credit

A home equity loan could give you access to a large amount at a lower rate than most borrowing options, even if your credit is less than ideal. However, the loan carries serious risks you should weigh first.

Learn more: Pros and Cons of Home Equity Loans

Should You Get a Home Equity Loan With Bad Credit?

Whether you should get a home equity loan despite having bad credit may depend on how urgently you need one and the strength of your overall finances. The loan may be a good option if you have enough steady income to comfortably afford the payments and need money for an urgent expense. For example, the cost of delaying an emergency home repair like a damaged roof or a broken heating system may be greater than the extra interest you'll pay because of your credit.

On the other hand, a home equity loan that is secured by your home may not be worth the risk if your income is unpredictable or the new payment would strain your budget. If the benefit doesn't outweigh the risk and the expense can wait, you may want to work on improving your credit before applying for a home equity loan. A stronger score could improve your approval odds, potentially with a lower interest rate.

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How to Get a Home Equity Loan With Bad Credit

Follow these steps to get a home equity loan, even if your credit is less than you'd like it to be.

1. Check Your Credit Reports

Before you apply, review your credit reports to see what lenders see when they review your application. You can get your Experian credit report for free anytime or get free weekly reports from all three major credit bureaus, Experian, TransUnion and Equifax, at AnnualCreditReport.com.

Look closely for information you believe to be inaccurate, especially errors that could hurt your credit score. A late payment reported by mistake could seriously damage your score, for example. You have the right to dispute inaccurate information on your credit report for free.

2. Take Time to Improve Your Credit

Taking steps to improve your credit, such as paying down debt, could help you qualify for a home equity loan. Higher credit card balances increase your credit utilization ratio, which can lower your credit score. So it's best to avoid using credit for large purchases when preparing to apply for a second mortgage. Paying down credit card balances could help you see score improvement relatively quickly.

Payment history accounts for 35% of your FICO^® Score, the biggest scoring factor, so make every effort to pay your bills on time. Using autopay to ensure at least your minimum payments are met can help improve credit.

Learn more: What Affects Your Credit Scores?

3. Calculate Your DTI

DTI, or the percentage of your monthly income that goes to pay your debts, is an important consideration in home equity loan approval. Make sure your DTI is 43% or less—the maximum most lenders allow—before applying for a home equity loan. You can calculate your DTI by adding up your monthly installment debt payments, including auto loan, personal loan and student loan payments, and your minimum monthly revolving debt payments on credit cards and lines of credit. Divide your total by your gross monthly income.

Example: If your monthly debts total $3,000 and you make $9,000 each month, your DTI is 33% ($3,000 debt / $9,000 income = 0.33 x 100 = 33%).

4. Determine Your Home Equity

To estimate your home equity, subtract what you owe on your mortgage from your home's appraised value. Lenders also evaluate your ability to borrow by reviewing your combined loan-to-value ratio. This calculation includes all loans secured by your home, including the one you're applying for. A CLTV of 85% or lower indicates you have sufficient equity to qualify for a new loan.

If your home is worth $500,000 and you have $250,000 to pay on your mortgage, you have $250,000 in home equity. With a 20% equity lender requirement, the total amount you could borrow would be $150,000. If you borrowed $100,000, the total debt on your home would be $350,000 and your CLTV would be 70% ($350,000 / $500,000 = 0.70 x 100 = 70%).

Tip: If your credit score is low, having more equity in your home may help offset risk for lenders and improve your approval odds. You can build equity by paying down your mortgage or making strategic home improvements that increase your home's value.

Learn more: How to Calculate Home Equity

5. Gather Your Financial Documents

Round up any documents that support the information you provide on your home equity loan application. For example, you'll need your pay stubs, W-2s or other acceptable documentation, account statements and tax returns as proof of income.

Tip:You might also consider submitting a letter of explanation with your loan application. For example, a brief note explaining that a job loss led to past late payments can show your lender that the setback was a one-time event and isn't likely to happen again.

6. Shop and Compare

Consider getting home equity loan quotes from several lenders to find the loan that benefits you the most. Look for loans that give you the best balance of low interest rates, closing costs and fees.

When comparing lenders, look for those that allow you to prequalify with a soft credit check, which doesn't affect your credit scores. Prequalification uses your basic financial information to estimate whether you'd qualify and what rates and loan amounts you might receive. If you have bad credit, this can help you avoid applying with lenders that are unlikely to approve you.

What to Do if Your Home Equity Loan Application Is Denied

If your home equity loan application is denied, contact the lender to understand the reasons behind their decision. Common reasons for denial include poor credit, income or employment problems, insufficient home equity or a low home appraisal. Once you discover the specific reasons why your lender denied your application, you can take steps to improve your approval odds the next time you apply.

Note: You have the right to request a credit report for free after a company takes an adverse action against you, such as denying your loan application based on your credit.

Also, keep in mind that each lender has its own home equity loan requirements, so being denied by one for bad credit doesn't mean others will do the same. Consider applying with other lenders, especially those with lower minimum credit score requirements. Just remember to keep applications within a two-week period to minimize credit score harm.

You could also add a cosigner to strengthen your application. If you are denied because of a low credit score or high DTI, a cosigner with strong credit and a low DTI may improve your chances of approval. However, the cosigner must be aware that they're responsible for repaying the loan if you default or miss payments, and their credit could be harmed as a result.

Alternatives to Home Equity Loans

A home equity loan can be a useful tool for consolidating debt, funding a home renovation or covering a large expense. However, your financial situation is unique, and other financing alternatives may be worth considering.

• Home equity line of credit (HELOC): Like a home equity loan, a HELOC is a second mortgage that uses your home equity as collateral. But unlike a home equity loan, which gives you the money in one lump sum, a HELOC works more like a credit card. You can borrow money as needed, up to your credit limit, during a set period.
• Personal loan: You may prefer a personal loan to a home equity loan because it typically doesn't require collateral, meaning your home isn't at risk. However, since it's an unsecured loan, you'll usually pay a higher interest rate than you would with a home equity loan.
• Cash-out refinance: A cash-out refinance allows you to access your home's equity by replacing your existing mortgage with a larger one. The lender pays off your current loan and gives you the difference in cash, minus closing costs. You can typically borrow up to 80% of your home's value with this type of refinance.
• 0% introductory APR credit cards: With a good credit score, you might qualify for a credit card with a 0% introductory APR for up to 21 months. You could use the card to cover a large unexpected expense and repay the balance without interest during that period.

Frequently Asked Questions

Improve Your Credit Before Applying for a Home Equity Loan

A home equity loan could help you achieve important goals like consolidating debt or covering a home improvement project. Some lenders may approve your home equity loan with a credit score as low as 620, although they may charge a higher interest rate.

Get ready to apply by working to improve your credit score fast. A higher credit score may help you qualify for more favorable interest rates for significant savings over the life of the loan. Get started by checking your credit report and score for free with Experian and addressing any issues you find.