A home equity loan stands out as a potential source of cash (if you own a home with equity in the property) to cover college tuition, renovations, or other expense.
Having a home equity loan with a lower credit score means you may face higher interest rates, lower lines of credit, and less favorable loan terms.
Most borrowers will find that home equity loans will still be significantly cheaper than alternative financing options, and many lenders are willing to be more flexible due to the high quality of the underlying collateral.
A home equity line of credit is a revolving line of credit that works in much the same way that a credit card does. Your HELOC will typically have a credit limit and a “draw period”.
You can borrow against available funds whenever you need money, repay it with interest and borrow again as long as you don’t exceed your credit limit.
But while certain credit cards and personal loans are unsecured credit, a HELOC is secured by the equity in your home. That means defaulting on a HELOC could put you at risk of losing your home.
Generally, banks limit the amount of home equity you can borrow to no more than 85% of a home’s appraised value, less whatever you owe on a first mortgage.
The Pros and Cons of a Home Equity Loan with Bad Credit
Fixed interest rate and consistent monthly payments
Easy to predict and budget for
Interest may be tax-deductible
Can be used to consolidate debt
More affordable than private loans and credit cards
Not every lender will be willing to underwrite the loan
Comes with a higher interest rate if your credit isn’t great
Adds a second monthly payment for many years
Uses your home as collateral, putting your property at risk
To Qualify for a Home Equity Loan with Bad Credit
Each lender has its own criteria for determining your eligibility and the loan amount you may qualify for, but they’ll typically review certain financial factors.
Debt-to-Income Ratio (DTI)
Your debt-to-income ratio is the amount of debt you have compared to how much you earn. It helps lenders determine your ability to repay loans.
Unlike primary or first mortgages, home equity loans don’t have preset DTI requirements. While most lenders will seek a DTIratio of below 40%, lenders are able to determine acceptable ratios for themselves, so there is some variation across the industry.
Loan-to-Value Ratio (LTV)
LTVis the calculation of your home value versus the equity you’ve put in so far. This usually takes into account the total amount of money you intend to borrow relative to your equity share.
For HELOCs, lenders assess your ability to repay the entire credit line, whether you draw the entire amount or not. This maximum figure is called the high combined loan to value (HCLTV).
However, let’s say you want to take out a HELOC instead. Assume that your HELOC has a $120,000 credit line and you want to draw $100,000.
In this case, the combined LTV ratio will still be 75%, but the HCLTV will be 80%. Lenders will look at the HCLTV ratio when evaluating your application for HELOCs, which will be tied closely to your home’s appraised value.
Your credit scoreswill affect your loan terms, interest rate, and odds of approval. Minimum score requirements for home equity financing start at 620, with some lenders requiring minimum scores between 640 to 680.
Lenders look for negative events such as bankruptcies, foreclosures, collections, liens, or judgments.
If you’ve previously declared bankruptcy, lenders will have set waiting periods after your bankruptcy is discharged before they will consider your loan application.
Bankruptcy discharge can take three to seven years depending on the lender. If you’ve previously experienced a short sale or foreclosure, you will usually need to wait at least five years before you’re eligible for home equity financing.
Obtaining a loan with a low credit score can be tough. Bad credit is a sign of mismanaged debt, which makes lenders hesitate to approve new loans. Think of it this way: Would you trust your possessions to someone who constantly loses their own?
In the end, lenders don’t want to give money to someone who might not give it back. And if your credit history shows you’ve had trouble repaying debt in the past, you’ll need to offer lendersmore than just your word; you’ll often need to provide some sort of collateral.
For consumers with low scores and few financing options, home equity loans, HELOCs, and cash-out refinance loans can be options for making use of carefully built home equity to secure a loan. But they’re not without risk.
The reason lenders accept the property as collateral is that they know they can typically sell the property to recover their lost funds should the borrower default on the loan.
While this is great for the lender, it means you’ll lose your home if you don’t repay your loan.
1. What is home equity?
Home equity is the difference between what you currently owe on your home and its appraised value in the current market.
2. How long does it take to close on a HELOC or Second Mortgage?
It should take no longer than four (4) weeks from application to closing.
3. Do I need to have great credit?
Your credit score is only one of the factors considered in the underwriting process, so having good credit, along with the other qualifications (sufficient equity in your home, allowable loan-to-value ratio, etc.) is usually sufficient for equity line approval.
4. How do I qualify for a HELOC?
In order to qualify for a HELOC, you will need to have available equity in your home. In other words, the value of your home must be more than what you owe.
5. Is the interest rate on a HELOC Fixed?
No. The interest rate is a variable rate subject to change on a monthly basis. When the interest rate changes, it changes the monthly payment amount.
Though getting a home equity loan with bad credit can be tricky, it’s not impossible by any means. As with any mortgage loan, it’s smart to shop around and get several quotes before deciding which lender to use on your home equity loan.
Compare the interest rate, APR, and terms, as well as individual fees and closing costs. Waiting until you have a decent amount of equity in your home can also help.
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