Real Estate
June 2, 2023
Getting a home equity loan with bad credit can be difficult, especially when you don’t have collateral. However, this process becomes easier if you can borrow against the equity you have built through years of making payments on your home. A home equity loan provides you with a lump sum that many homeowners use to make home improvements. You repay the loan over time, just like any other loan. This approach still requires you to meet the lender’s standards, but the buildup of equity in your home will make it easier to meet those standards. The factors that determine whether you will qualify for a home equity loan include the following:
- Credit score
- Debt-to-income ratio
- Home equity
- Cash-out refinance
Credit Score
Your credit score isn’t as important in qualifying for a home equity loan as it is in getting an unsecured loan, although the score will have a significant effect on the interest rate you will pay. Home equity lenders typically want borrowers to have a FICO score of at least 620. Key factors in determining the score you’ll need for a home equity loan are your debt-to-income (DTI) and loan-to-value (LTV) ratio.
Debt-To-Income Ratio
The DTI is the total of your debt payments divided by your total income for a given time period, typically monthly or annually. Lenders usually multiply DTI by 100 to obtain a percentage. Most home equity lenders prefer a DTI of no more than the lower 40s, but you can find those willing to consider a higher DTI if you shop around. Lenders consider both your credit score and DTI, so a lackluster score on one may require a better score on the other.
Home Equity
The maximum amount you can expect to receive from a home equity loan is based on the equity you have in your home. Equity is the value of your ownership in the home, which you can calculate by subtracting what you owe on the house from its fair market value. For example, if your home is worth $300,000 and you owe $200,000 on it, your equity in that home is worth $100,000.
Home-equity lenders typically limit your loan to a certain percentage of your equity. Most lenders will lend you 80 percent of your equity. If your equity is worth $100,000 and a lender is willing to lend you 80 percent of your equity, the most you can expect to borrow is $80,000.
Cash-out Refinance
A cash-out refinance is another option if you don’t qualify for a home equity loan. This approach involves replacing your current mortgage with a new loan in a larger amount. The lender provides you with a lump sum payment that represents the difference in value between the old and new loans. Lenders have more leeway in underwriting a refinance because it isn’t a second mortgage. Thus, the interest rates on refinances generally are lower than those for home equity loans. However, closing costs on refinances are likely to be higher because the lender is underwriting a brand new loan.
Key Takeaways
Using home equity with a low credit score will be difficult but not impossible provided you have a low debt-to-income ratio, substantial equity in your home, and an income that will allow you to make the additional loan payments. Talk to a financial advisor today to see if a home equity loan will work for you.
If you’re interested to know how to get home improvement loans with bad credit scores or loans that don’t require any credit score, don’t hesitate to connect with us today!
