Home Equity Loans for Bad Credit
Loans are powerful tools, giving you money you need for major purchases or large expenses when you need the entire cost right now. Of course, not all loans are created equal. If you’ve had problems with your credit in the past, you may have difficulty finding a loan that meets your needs. Even if you can find a loan, many loans for bad credit have either small borrowing amounts or high interest rates (or both!).
If you own a home, you may still have options. You can leverage the equity in your home to secure a loan, giving you access to a higher borrowing amount and better interest rates than you might otherwise qualify for based on your credit score. Home equity loans shouldn’t be taken out lightly, though. Here are some of the most common questions about home equity & bad credit so you can decide whether one of these loans is right for you and your financial situation.
What Is a Home Equity Loan?
A home equity loan or HEL is a specialized type of secured loan. While many secured loans use some form of physical collateral to guarantee repayment, a HEL uses the equity that you’ve built up in your home instead. This equity is the value you’ve built up as you’ve made payments on your mortgage, and some people view it as the portion of your home’s value that you actually “own.”
Because you’re borrowing against the value of your home, you may hear home equity loans referred to as a “second mortgage.” This is because you’re using a mortgage instrument to secure the equity you’re cashing out. You now have two mortgages, the one that you purchased your home with and the home equity loan that you’ve just closed. The loans function essentially the same way—just remember that you’ll still need to keep up on your primary mortgage payments as well.
Can I Really Get a Home Equity Loan with Bad Credit?
A home equity loan has the value of your home’s equity behind it, giving you some very strong collateral to secure the loan. This allows lenders to offer HELs to people who might not qualify for other loans because they’ve had credit problems in the past. While your credit score will likely still come into play, the value of the equity in your home and the amount you wish to borrow against it will carry significant weight in the loan decision as well.
What Credit Score Is Needed for a Home Equity Loan?
For your typical loan, lenders prefer borrowers who have credit scores of 680 or higher. While you might be able to get a loan with a lower score, the terms and interest rate won’t be nearly as good and collateral or a cosigner may be required. But if you’re applying for a home equity loan, this changes a bit.
With a HEL, you can have a notably lower credit score and still receive decent terms on your loan. In some cases, you may be able to get a loan that’s not horrible with a credit score as low as 620. You may even find lenders willing to work with a lower credit score than this, though you’ll need a significant amount of equity and still may find that the terms of the loan aren’t ideal.
How Much Equity Do I Need?
The amount of equity you need to secure a home equity loan depends on your lender, but you’ll generally have to have at least 30% equity before you can qualify for a loan. Keep in mind that you won’t be able to borrow against that full amount, either; this is why the minimum exists, since an amount of equity lower than 30% could result in a small-value loan that wouldn’t be worth taking out.
What Else Do I Need to Get a Loan?
To get a home equity loan, you’ll need to provide some paperwork as proof of the value of your home and your ability to pay the loan back. For most lenders, this means you’ll have to provide an appraisal of your home and related information concerning its value and the equity you’ve built. You’ll also need to give the lender some proof that you’re employed, along with proof of income and your most recent tax returns to show your annual income and general financial stability. Proof of homeowners insurance and other home protection information will likely also be required.
Is a HEL the Same as a Home Equity Line of Credit?
Given the similarity in names, it’s understandable why some people think that a home equity loan and a home equity line of credit are the same thing. There are definite similarities, of course; both use the equity you’ve built up in your home as collateral to secure the loan, and depending on the specific loan you consider, they may even have similar repayment periods. But there are a few key differences between the two loan products.
A home equity loan is received as a lump sum upon taking out the loan, whereas a home equity line of credit establishes an amount that you can borrow against over time. You can make payments toward your line of credit during this time, reducing the amount that you owe and freeing up more credit in the process. Once the borrowing period ends, repayment begins like a standard loan. You have control over how much there is to repay, of course, since you’ll only have to repay the credit balance at the time of the switch.
Can a Home Equity Loan Help My Credit?
Because it’s an installment loan that you’ll make payments to every month, your home equity loan can definitely have a positive impact on your credit score. As you make payments on time and in full, the lender who issued the loan will report that your loan is in good standing on a regular basis. The more positive reports you receive, the better your credit score will be. As some of your other debts age or expire from your credit file, these new positive reports will carry even more weight and could result in significant improvements to your credit score over the loan’s repayment period.
Can a Home Equity Loan Hurt My Credit?
One important thing to keep in mind is that a home equity loan will only help your credit score for as long as you’re actually making your payments on time and in full. If you start falling behind on your loan payments, the lender will report your account as delinquent. A single delinquent payment may only cause a temporary hiccup in your credit score, but frequent late or missed payments will have a definite negative effect on your credit. Not only that, but if you start missing your loan payments, you could actually put your home at risk as well.
What Options Do I Have with a Home Equity Loan?
Though the basics of home equity loans seem pretty straightforward, you may actually have a lot of options regarding the specifics of your loan. The options available will depend on your lender, but you may be able to get either a fixed or variable interest rate and one of several repayment terms.
How Much Can I Borrow?
The amount that you can borrow depends on your lender, but it’s typically expressed as a percentage of the equity you have in your home. Though the exact number may vary as your lender evaluates your credit score and other factors, the typical home equity loan can be for up to 80% of the equity value in the home. This is known as the loan-to-value ratio, or LTV.
The LTV is also a good part of the reason for a minimum equity amount for HELs. If you only have 30% equity in your home, you’ll only be able to borrow around 10% of the home’s value. If you had a smaller percentage of equity than that, a single-digit percentage of your home’s value wouldn’t be worth the time or risk for the lender.
How Long Do I Have to Pay It Back?
The specific repayment time will depend on the amount you borrow, the general terms of your loan, and the loan products that your lender offers. But in general, most home equity loans allow you between 10 and 20 years to complete repayment. If you have difficulty repaying the loan within this time frame, you may be able to refinance it after you’ve paid down the principal to secure better terms or spread out the loan over a longer period.
What Can I Use a Home Equity Loan For?
Typically, home equity loans are used to make one or more large purchases or a single large payment. Though many high-value items (such as a car or boat) could serve as collateral on their own loans, you may be able to get a better interest rate with a home equity loan given your less-than-perfect credit. If you’re making multiple purchases or paying for repairs or improvements after making your initial purchase, the HEL gives you a single loan to repay instead of multiple payments to keep track of. Other uses of home equity loans include raising money for investment, starting a business, or consolidating multiple debts into a single payment.
This illustrates another big difference between home equity loans and home equity lines of credit. A HEL is typically used when you need to spend money in a short period of time. With a line of credit, you’re more likely to make multiple smaller purchases over time. Lump-sum loans are good when you need all of the money right now, while lines of credit are good if you need to have access to money over several months.
How Can I Find the Right Lender?
As with any loan, your home equity loan will only be as good as the lender you choose. Since you’re coming from a position of less-than-perfect credit, finding the right lender is especially important. If you don’t choose your lender carefully, then you may end up with a higher interest rate, a lower loan amount, and generally worse terms than you could qualify for elsewhere.
To find the lender that’s right for you and your loan, take the time to shop around and get loan quotes from a few different lenders. Visit banks, credit unions, or other lenders that might be available to you so you can see which HEL options they offer. You don’t have to take the first offer you receive; shop and compare different loan options to find the one that gives you the best possible loan you can qualify for.
Can I Improve My Loan Terms?
It’s possible that even after shopping around, you might not find a loan that features the favorable terms you’re looking for. In this case, the problem is likely that either you don’t have enough equity in your home or your credit score is too low to qualify for better terms. It’s possible to fix both of these problems, but it does take a bit of time.
As early as possible, start making additional payments toward your mortgage to increase the amount of equity you hold. You should also work on getting all of your bills and debts current if they aren’t already and paying down any credit cards you have. If you can afford it, try to bring delinquent debts current as well to minimize their effect on your credit score. You should also get a copy of your credit report so you can look for any questionable or incorrect information that you can dispute with the credit agencies.
If possible, allow at least four to six months of this payment activity before applying for a loan. The longer you can maintain it, the greater the benefit will be. Increasing your equity will make lenders more forgiving of your less-than-perfect credit, and trying to improve your credit score will lessen its impact as well. Just make sure that you don’t drive yourself deeper into financial trouble by trying to pay too much at once.