Bad Credit Series: 125% Home Equity Loans
Most of the time, the value of a loan is based at least in part on the value of any collateral that’s securing it. In the case of home equity loans, the value comes from the amount of equity you’ve built up by making payments against your mortgage. The exact amount that you can borrow depends on a few different factors, but it’s usually capped by the loan’s loan-to-value (LTV) ratio. For most home equity loans, this is set at around 80%, meaning that you can’t borrow more than around 80% of the value of your equity.
There is another type of home equity loan that you’ll see occasionally, though: the 125% home equity loan. Sometimes referred to as “no equity” loans, these loans do exactly what their name implies—they let you borrow up to 125% of the value of your equity. If you’re wondering how this possibly works, it might make more sense in a minute.
The 125% Home Equity Loan
At first it seems silly to think that there’s really a loan out there that lets you borrow more than your home’s equity is worth. But it’s not so ridiculous when you stop and think about it. Even though the “125%” figure sounds impressive in relation to your home’s equity, it means that 4/5 of the loan’s value is still secured by that same equity. This leaves you with only 1/5 of the loan unsecured, meaning that the lender already has a way to recoup most of the loan’s value even if you default on the loan.
Perhaps more importantly, if you were to default, it’s not likely to happen right away. Most borrowers who default try to repay what they owe for some time. It’s often years before borrowers become delinquent on their payments, and even longer before they default completely. In that time, you’ll likely have already repaid that 1/5 of the loan that’s not covered by your collateral and then some. If the lender has to put your loan into collections or initiate foreclosure, it stands a very good chance of recouping its entire investment in your loan.
What Are 125% Home Equity Loans Used For?
The majority of 125% home equity loans are used for debt consolidation. The larger amount of these loans allows you to include a number of different debts under the consolidation umbrella, reducing most if not all of your outstanding debt to a single monthly payment. Because your loan is secured by the equity in your home, you should be able to repay that single loan with a decent interest rate as well. This is especially useful if some or all of the debts you want to consolidate have higher rates.
Some borrowers also use 125% home equity loans to refinance large loans such as a primary mortgage. If you have at least 50% equity in your home, you could use one of these loans to completely pay off the remaining portion of your existing mortgage. Once the mortgage is paid off, you only have the home equity loan to repay under (theoretically) more beneficial terms than those of your original mortgage.
Depending on your lender, there may be other qualifying use cases available for these loans as well. They aren’t often used for large purchases, as other types of loans may be more appropriate, but you might attempt to use one of these loans to pay for repairs and rehabilitation of real estate or for a large capital endeavor such as starting a business or making a significant investment. But these would be fringe cases at best, with debt consolidation or refinancing being the most common use of a 125% home equity loan, bad credit or good.
Qualifying for a 125% Home Equity Loan
To qualify for a 125% home equity loan, you’ll need documentation of your current financial status. This includes recent pay stubs to serve as proof of employment, tax returns to show your annual income, and any required assessments or other information to prove the value of your equity. Personal information is needed as well, especially identifying information so that the lender can check your credit score.
This is where a lot of potential borrowers run into trouble. Because you’re borrowing more than your equity is worth, most lenders require you to have pretty good credit to qualify for a 125% home equity loan. While many home equity loans are fairly forgiving when it comes to less-than-perfect credit, these specific loans are much harder to get if you don’t have a high credit score.
125% Home Equity Loans and Bad Credit
It is difficult to get a 125% home equity loan with bad credit, but that doesn’t mean it’s impossible. Most of the time, you’ll need to have a cosigner with a high credit score to offset your own credit problems. You can also shop around and get an idea of the credit scores that different lenders require in your area. It’s possible that you’ll find lenders that work with lower credit scores than some of their competitors, giving you a way to qualify for the loan even without perfect credit.
Depending on how low your credit score is, you can also take steps toward improving your overall credit rating before you apply for a loan. This can take several months to really get going, but the end result can significantly improve your life. Check your credit report for incorrect or questionable entries, contacting the credit bureaus in writing to dispute the items and have them removed from your report. You can also work to keep your other accounts current and pay down credit cards or bills, setting up a number of improvements to your credit score over time.
It isn’t easy to qualify for a 125% home equity loan starting from bad credit, but the effort will be worth it if the loan helps you get your finances under control. If you still can’t qualify for the loan, then the improvements you made to your credit report may help you find other home equity loan products that you’ll have an easier time qualifying for.