Do you need to access your home equity, but you’re worried that your low credit score will prevent you from getting approved? You’re in luck! Today having less-than-perfect credit scores is more common than you think, and some lenders are willing to work with homeowners with bad credit.
So, whether you’re looking to renovate your home, consolidate debt, or pay for unexpected expenses, there’s a way to access the funds you need, even with less-than-perfect credit.
Find the best way to unlock your home equity
House Numbers helps you access your home equity to pay off debt, fund home improvement, or general expenses.
Understanding home equity loans
A home equity loan is a second mortgage loan that allows homeowners to borrow money against the value of their home. The loan is secured by the equity in your home, which is the difference between the current market value of your home and your remaining mortgage balance.
When you take out a home equity loan, you receive a lump sum of money that is repaid over a fixed period of time, with a fixed interest rate, usually between 10 and 30 years. In contrast, a home equity line is a line of credit you can draw money from during the initial draw period, which is usually the first 10 years, and repay the loan over the following 10 to 20 years.
In my experience, most home equity lenders have a minimum credit score requirement of 660 for a home equity loan, while very conservative lenders will require a 700 middle score. If you’re trying to get a home equity loan with bad credit, the pool of available lenders is small.
The importance of credit scores in home equity loans
Credit scores play a crucial role in the approval process for home equity loans. Your credit score is based on factors such as your payment history, credit utilization, length of credit history, and types of credit accounts.
Lenders use your credit score to determine whether you are a high-risk borrower, and to set the interest rate on your loan. If you have bad credit, which is usually under 620, it can make it more challenging to get approved for a home equity loan.
One reason why it’s more challenging is that it places you into a higher interest rate bracket which simultaneously raises your monthly payments and debt-to-income ratio. If your monthly debt payments are high compared to your gross monthly income, it may cause you to make minimum monthly payments.
In my experience, this usually means you’ll have a high credit utilization ratio, which tends to include substantial credit card balances every month. I recommend that homeowners seeking an attractive loan get a free credit report online and check for any errors.
| Credit Score | Primary Home (maximum LTV) | Rate |
|---|---|---|
| 740 and above | 95 LTV | 8.875 – 13.25 |
| 700 – 739 | 95 LTV | 9.625 – 14 |
| 680 – 699 | 90 LTV | 10.25 – 13.25 |
| 660 – 679 | 85 LTV | 10.75 – 13.75 |
| 640 – 659 | 70 LTV | 12 – 13.25 |
| 620 – 639 | N/A | N/A |
See the chart above for illustrative purposes of a lender’s underwriting credit grade matrix. For a better understanding, the LTV acronym is for loan-to-value. However, when loan professionals are discussing home equity loans or home equity lines, they will say CLTV for “combined loan to value”. It’s important to note that this table is just a common example and is subject to change, especially as interest rates change.
Example
Here’s an example of a borrower who applied with us recently. He wanted to get a home equity loan of $150,000 to upgrade his home. This new second mortgage would place him in the 75 CLTV (combined loan to value) bracket.
He had a middle FICO credit score of 676 which corresponded to an interest rate of 11.5%. If he had a middle credit score of 760 or higher, his rate would be 9.5%. That’s a whopping 2-percent difference and a monthly payment difference of $224.
This means he will have to pay $40,320 extra over the course of the loan term (30 year loan) than if his credit was closely monitored and he had credit scores over 760. We reviewed his credit report and found his problem was high credit utilization.
His revolving debts (credit cards) were at 50% or more of their maximum limits as opposed to ten percent or less that 800 FICO borrowers tend to have. Additionally, there were a couple of 30-day late payments on two accounts in late 2020 possibly due to being late on some bills due to the pandemic.
However, after showing the borrower the payment difference, he didn’t mind. The reason why is he was going to use the funds to construct a granny unit (or “ADU”) with a private entrance and no shared space with his home. He decided he could rent it out on a short-term basis when relatives are not visiting and receive an additional monthly income.
Moreover, the addition will add value to their home over the long run. Essentially, this cash out home equity loan will pay for itself while adding value. That’s a win-win for the homeowner with bad credit.
What this shows you is even if you have low credit scores or bad credit it does not stop you from achieving your financial goals with a home equity loan. There’s home equity lenders with loan programs that may fit your exact needs or at least offer a loan amount that can still help you.
Home Equity Loan Alternatives for Low Credit Scores
If you have a lower credit score and experiencing difficulty getting approved for a home equity loan, there are alternative options available to you.
One option, if possible, is to pay down any credit card debts to ten percent of their maximum credit limit and re-apply in a month because that’s when your scores will increase. This will improve your debt-to-income ratio and hopefully lift you out of the bad credit score threshold.
A second option is to consider a cash-out refinance, which involves replacing your existing first mortgage with a new one that has a higher balance. The difference between the two balances is paid out to you in cash, which can be used for a variety of purposes, such as unpaid medical bills.
However, the interest rates you can expect to receive will be higher than those available to borrowers with good credit or those only wanting to refinance their existing mortgage balance. As for the maximum LTV on a primary home, it depends on the type of loan.
Find the best way to unlock home equity
Refinance First Mortgage
Many homeowners have the option of refinancing their first mortgage. Depending on what type of mortgage you have and your interest rate, this option may suit you.
- VA loan: the maximum loan amount you can receive is the full amount of your home’s equity with a 620 qualifying credit score. This means your new loan balance may be the same value as your home. Otherwise, if you keep 10% equity in the home after the refinance you can do VA cash-out refinance a minimum 580 FICO score.
- FHA loan: to qualify for an FHA refinance with cash back, you must have a credit score of at least 500 according to FHA’s official guidelines and more than 20% in home equity. However, lenders have their own credit overlays and typically want a minimum credit score of 580 to refinance and get cash back. Getting a loan approval for an FHA refinance is considered easy by most lenders.
- Conventional loans: the maximum LTV ratio for a primary residence is typically 80% and the minimum credit score requirement is 620. However, some lenders may offer higher LTV ratios, up to 95%, but the borrower will likely have to pay a higher interest rate.
It’s important to note that mortgage lenders may have varying minimum credit score requirements and LTV ratios, so it’s best to shop around to see what different lenders can offer you to tap into your home’s equity.
Home Equity Investments (HEI)
Home Equity Investments are a relatively new way to get cash from your home equity, particularly for those with low or bad credit scores. It’s an innovative, accessible method for homeowners to access cash tied up in their homes because, unlike a traditional loan, a home equity investment involves an investor providing a lump sum of cash to the homeowner in exchange for a percentage of the future value of the property.
This alternative financing option does not require monthly repayments or accrue interest. Instead, the investor is repaid when the home is sold or at the end of the agreed-upon term, receiving a portion of the sale proceeds equivalent to their investment stake. Consequently, your credit score does not impact your eligibility, making home equity investments an attractive solution for homeowners with low or bad credit who need access to funds.
Before assuming that HEIs are the perfect solution for you, make sure to review a few of the drawbacks:
- Share of Appreciation: An HEI entitles the investor to a share of the property’s future value, which means if your home appreciates significantly, you could end up paying back much more than you initially received.
- Early Termination Fees: Some HEIs come with hefty early termination fees if you decide to end the agreement before the specified term.
- Costs Over Time: Although there are no monthly repayments, the total cost of an HEI can exceed that of other financing options over the long term due to shared appreciation.
To learn if Home Equity Investments are right for you, speak to a mortgage professional or signup for House Numbers.
Reverse Mortgage
A reverse mortgage presents an excellent opportunity for homeowners, particularly those with low or bad credit scores, to convert their home equity into cash. With a reverse mortgage, instead of making monthly payments to a lender, the lender makes payments to you, the homeowner. This feature makes the reverse mortgage a compelling option for those who might struggle with traditional lending due to poor credit.
However, it’s critical to understand that a reverse mortgage is not for everyone:
- Age Restriction: Reverse mortgages are typically only available to homeowners aged 55 or older.
- Living Arrangement, Maintenance, & Taxes: Borrowers must continue to live in the home as their primary residence. The homeowner is still responsible for home maintenance, property taxes, and homeowners insurance. Failure to meet these obligations can lead to the loan becoming due.
The biggest downside that most homeowners have with reverse mortgages is that it eats into a large chunk of their home equity. For example, upon the borrower’s passing, moving out, or failure to meet obligations, the loan must be repaid, which impacts inheritance for your heirs. Reverse mortgages also come with hefty fees and interest that can add up over time, reducing the equity left in the home.
Consideration of these aspects is crucial when contemplating a reverse mortgage as a method to tap into your home’s equity. Always seek the advice of a trusted financial advisor before making such a significant decision.
A personal loan
If you’re unable to get a home equity loan with bad credit, a personal loan may be another option to consider. Personal loans are typically unsecured loans, meaning you don’t need to put up any collateral like your home.
However, since personal loans are not secured by an asset like home equity loans, they are usually associated with higher interest rates for borrowers with subprime credit scores, so it’s important to shop around and compare rates from various lenders.
You may find that some subprime credit lenders are willing to work with you, but understand that you may be offered a shorter repayment period and higher interest rates compared to borrowers with good credit. Some subprime loans also come with origination fees, which can add to the overall cost of the loan.
Despite these drawbacks, a personal loan can still be a viable option for those who need quick access to cash and can’t qualify for a home equity loan with bad credit. Just make sure to do your research and compare interest rates and terms for unsecured personal loans from different lenders before making a decision.
A debt consolidation loan
Another alternative to a home equity loan for bad credit borrowers is a debt consolidation loan. This type of loan combines all your debts into one payment, potentially making it easier to manage your finances.
If your credit score is below 640, you may have limited options to consolidate and refinance your current debt. Traditional lenders typically require good credit scores and collateral to secure loans. However, there are some subprime credit lenders that offer unsecured loans to borrowers with poor credit scores but understand you will likely have to pay higher interest rates.
Interest rates for debt consolidation loans can vary depending on your creditworthiness and the lender. According to financial news sources, subprime lenders can charge interest rates from 10% up to 35% to combine your debts into one loan. Repayment terms may range from one to five years, while some lenders may offer longer repayment periods up to ten or even fifteen years.
While it may simplify your debt payments, you may end up paying more in interest over the life of the loan. Make sure to shop around, and compare rates and the loan amount from various lenders at HouseNumbers before making a decision.
A 401(k) loan
Another alternative for those with bad credit who are unable to secure a traditional home equity loan is accessing your 401(k) retirement account for the needed funds. However, it’s important to weigh the potential risks and benefits before deciding to get a loan on your 401(k) because it may affect your retirement savings.
One advantage of a 401(k) loan is that there are typically no credit report, gross monthly income requirements, or closing costs, making it an accessible option for those with poor credit. Additionally, the interest rates on 401(k) loans tend to be lower than those on unsecured loans like personal loans or credit cards.
It’s important to note that 401(k) loans typically have a maximum borrowing limit of either $50,000 or 50% of your account balance, whichever is less. This may not be enough to cover large expenses like a home renovation or consolidating existing debt.
Maybe one or all of these home equity loan alternatives will work for you. Personally, if I had to pick one of the above that’s not a mortgage, I would make sure I have a solid plan to repay it back as soon as I can.
Finding lenders who offer bad credit home equity loans
When searching for lenders who offer a home equity loan with bad credit, it’s important to do your research and compare options from multiple lenders. Look for lenders who specialize in borrowers with less-than-perfect credit and who can offer competitive interest rates.
You may also want to consider working with House Numbers, who can help you find the best home equity loan options based on your individual financial situation and bad credit.
Finally, be patient and persistent in your search for a home equity loan. It may take some time to find a lender who is willing to work with you so you can access the funds you need to achieve your goals.
