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If you own a home, you can tap into your home's equity to finance a home renovation project, pay off high-interest debt or for just about any purpose you wish. But to do so, you'll typically need a FICO® Score☉ of at least 680 to qualify for a home equity loan or home equity line of credit (HELOC).
It's possible to get approved for a home equity loan with a credit score below 680, but it will likely come with unfavorable terms, such as a higher interest rate, a lower loan amount or a shorter repayment term. If your credit is below average, taking steps to improve it before applying for a home equity loan may be your best option.
What Is a Home Equity Loan?
A home equity loan, a type of second mortgage, allows you to borrow against the equity in your home. Equity is the percentage of your home's value that you actually own; in other words, the difference between what you owe on your mortgage and your home's current market value.
With a home equity loan, the amount you can borrow will depend on the amount of equity you have in your home. Generally, lenders allow you to borrow up to 80% of your home's equity. You'll receive the funds in one lump sum, which you'll repay in fixed monthly installments over a fixed term ranging from five to 30 years. If you fail to make your payments and default on the loan, you could lose your home to foreclosure.
What Credit Score Do I Need to Get a Home Equity Loan?
In most cases, you'll need a credit score of at least 680 to qualify for a home equity loan, but many lenders prefer a credit score of 720 or more. Some lenders will approve a home equity loan or HELOC even if your FICO® Score falls below 680. In that case, your financial profile will need to be strong in other areas, such as your income or overall debt.
Can I Get a Home Equity Loan With a Low Credit Score?
While your credit heavily influences your eligibility for a home equity loan, it's not the only criteria lenders consider. If your credit is below 700, you may still qualify for a home equity loan, especially if you have a low debt-to-income ratio (DTI) or substantial home equity.
DTI measures the amount of your total monthly debt obligations relative to your gross monthly income. Lenders typically want your DTI—including the home equity loan—to be no more than 43% of your monthly gross income.
Another way to alleviate a lender's concern about a lower credit score is to demonstrate sizable equity in your home. Most lenders require you to have at least 20% equity to qualify for a home equity loan. But the more home equity you have, the less risk a lender inherits. In a worst-case scenario, the lender can sell the property and pay off the mortgage, and there would likely still be enough proceeds to cover your outstanding home equity loan balance.
Other Home Equity Loan Requirements
Besides maintaining a good credit score, you'll need to meet the following eligibility requirements to qualify for a home equity loan:
- Sufficient home equity: Home equity loans typically require you to have a minimum of 80% loan-to-value ratio (LTV). LTV measures the size of your loan compared to the value of the property you're using as collateral. Your lender will likely require a home appraisal to ensure it has adequate equity to secure the loan.
- Proof of income: Lenders want to know if you have the necessary resources to make your monthly payment. Be prepared to produce W-2s and recent pay stubs as proof of income.
- Low debt-to-income (DTI) ratio: As a general rule, your DTI ratio shouldn't exceed 43%. If your credit is poor, your DTI may need to be considerably lower.
- Strong payment history: Even though your payment history is factored into your credit score, lenders may look closely at your payment history to see how well you manage your money. A consistent history of on-time payments indicates you're a responsible borrower. By contrast, a spotty payment history may make you appear risky to a lender even if your credit is otherwise strong.
- Proof of insurance: Most lenders will require you to hold homeowners insurance to protect your collateral.
Alternatives to Home Equity Loans
A home equity loan is one way to pay for a home improvement project, a large expense or any purpose you wish. But there may be better options than this type of loan. Here are some financing alternatives to consider:
Home Equity Line of Credit (HELOC)
Like a home equity loan, a HELOC is a second mortgage that uses your home equity to secure the loan. However, a HELOC operates more like a credit card since you can draw from your HELOC and repay it all at once or a portion of it monthly.
Similarly, you can borrow up to your full credit limit or only as needed. The latter option can help you save money since you only pay interest on the amount you withdraw. HELOC lenders may allow you to borrow up to 85% of your home's equity, although the amount may vary by lender.
The minimum credit score for a HELOC also varies, but lenders usually prefer a credit score of 700 or higher. As a general rule, lenders reserve the lowest interest rates for borrowers with the highest credit scores.
Personal Loan
A personal loan is another financing option you can use for just about any expense. Often referred to as debt consolidation loans or signature loans, these loans are unsecured, with repayment terms ranging from a few months to seven years or more.
Without collateral to offset a lender's risk, personal loans usually come with higher interest rates than a home equity loan.
Cash-Out Refinance
A cash-out refinance is another mortgage option to access the equity in your home by replacing your existing mortgage loan with a larger one. Your lender will pay off your existing loan and disburse the difference to you, minus any closing costs.
Most lenders allow you to borrow up to 80% or 85% of your home's value, but you'll likely have to pay private mortgage insurance (PMI) if you borrow more than 80% LTV.
0% APR Credit Cards
With good credit, you may qualify for a 0% intro APR credit card with a promotional interest-free period lasting as long as 21 months. If you can pay off your balance in full before the 0% APR period expires, you'll avoid interest costs entirely. Remember, once the introductory period ends, you'll have to pay interest on any remaining balance, usually at a substantially higher interest rate.
The Bottom Line
Home equity loans can be an effective option to access funds if you own a home and have sufficient equity in it. With fixed interest rates and payments and larger borrowing amounts than other forms of credit, a home equity loan may be suitable for your needs.
However, you'll usually need a FICO® Score of at least 680 for a home equity loan. If your credit score isn't where you'd like it to be, consider improving your credit before applying for a new loan. Start by getting a free credit report and credit score from Experian to see where your credit stands. Review your credit reports and dispute any valid errors or unauthorized charges to have them removed.