How to Qualify for a Home Equity Loan with Bad Credit

Home equity loans allow you to turn your home equity into cash, which can be used for renovations, debt consolidation, and more. If you’re a homeowner, you may have a significant amount of equity. Collectively, U.S. homeowners have more than $17.6 trillion in equity with the average homeowner surpassing $315,000 in equity, according to CoreLogic. 

But if your credit score needs work, you may have a harder time accessing your home equity. Learn more about the requirements for a home equity loan, how your credit impacts these types of loans, and what pros and cons to consider before you apply. 

Can you get a home equity loan with bad credit?

Yes, it is possible to get a home equity loan with bad credit, but it might be harder to find a lender and you may not get the best offers.

Home equity loans are considered nonqualified mortgages, which means the lender follows its own rules, explains Alexa DePaolo, branch manager of Prosperity Mortgage Group. “There are certain companies that do not care how low your credit score is,” DePaolo says.

To take on the risk of someone with a lower credit score, lenders may have other requirements to meet, she says. These are called compensating factors. 

Some examples include:

• A large amount of cash reserves in the bank
• A low debt-to-income ratio (DTI) 
• A large amount of equity
• Credit history trending positively

The loan you’ll be offered will likely be more expensive than someone with great credit might receive, too. Higher interest rates, closing costs, and terms are all normal for a low-credit home loan. 

Requirements for a home equity loan with bad credit

These compensating factors show up in the home equity loan requirements. These are what you can expect to see when you’re looking for a home equity loan for poor credit.

Equity

You’ll need anywhere from 15% to 20% equity to remain in your home after you’ve taken out the new loan. That means your new loan plus your existing mortgage can be no more than 80% to 85% of your home’s value. This is known as the combined loan-to-value ratio (CLTV). Some lenders may require significantly more equity in the home if your credit is on the lower end. 

For example, if your home is worth $500,000, your maximum CLTV could be around $400,000, which is 80% of your home’s value. But it may be possible that the lender requires more equity if your credit isn’t great. You might only be able to get a loan with a CLTV of $200,000 or $300,000. 

Sufficient income

Even with a large amount of equity in your home, you’ll need to make enough money to cover the monthly payment and your existing debts. Otherwise, you won’t be approved for the loan. Requirements vary from lender to lender, so be sure to shop around and find the best terms for you. 

DTI under 43%

To qualify for a home equity loan, you’ll need low levels of debt. You’ll need to be able to cover a new loan payment along with the debt payments you’re already making. If your credit score is low, the lender may require an even lower DTI ratio to compensate.

High credit

The better your credit, the better your odds of approval. You’ll also be eligible for lenders’ best interest rates when you have good credit. 

Strategies to improve chances of approval with bad credit

You can boost your chances of getting a home equity loan by improving your borrower profile where you can. These strategies could help strengthen your application.

Work on your credit score

To improve your credit score, check your credit report and dispute any errors. You can also pay down balances, set up automatic payments, consolidate debt, and wait to apply for new lines of credit. 

Pay off a debt

If you have a loan close to being paid off, you may want to consider paying it off completely. The monthly payment on this debt is figured into your DTI and decreases the monthly amount you can qualify for on a new home equity loan. If you pay it off, you’ll likely qualify for a higher loan amount. 

Additionally, if you have a medical debt in collections, paying that off means the negative mark on your credit falls completely off. 

Increase your income

Earning more income changes the debt-to-income equation so you can afford an additional payment. You may also be able to pay off more debt with an increased income if you pick up a part-time gig.

Increase available home equity

To increase your available home equity, you could try to raise your home’s value. While a full renovation may not be in order, some sprucing up to improve your home’s curb appeal could be a smart move. If there are upgrades your home needs, see if there are any you can handle yourself.

Also recommended: FHA vs. Conventional Loans 

Pros and cons of a home equity loan with bad credit

There are some pros and cons to consider, especially if you’re weighing a home equity loan with bad credit:

Pros

• Lower interest rate: Get access to financing at a lower interest rate than a personal loan or a credit card.
• Larger loan amounts: A home equity loan may grant you access to a larger loan amount, depending on your available equity. Credit cards and personal loans typically have lower limits. 
• Use funds how you see fit: A home equity loan can be used for a wide variety of purposes. 

Cons

• Higher interest rate: Even though a home equity loan offers low rates when compared against personal loans and credit cards, if you have poor credit, you’ll still see high interest rates.
• Risk of foreclosure: Since your home is used as collateral on the loan, the lender could foreclosure against you if you don’t make payments.
• Increased debt burden: By taking out a home equity loan, you’ll have debt to repay. 
• Less equity in your home: When you borrow against your home, you’ll decrease the amount of equity you have. 
• Closing costs: You’ll likely pay closing costs for a home equity loan. It’s not uncommon to see these folded into the loan, though, which can reduce your upfront cost but increase your payment.

Alternatives to a home equity loan for bad credit

If you’re looking for home equity loan alternatives, consider the following:

• Home equity line of credit (HELOC): A HELOC is a line of credit that is used as you need it, instead of a lump sum you receive at once. Qualifying with bad credit may be similar to a home equity loan. 
• Home equity agreement: A home equity agreement provides upfront cash in exchange for a portion of the home’s future equity. According to Michael Micheletti, chief communications officer at home equity fintech provider Unlock Technologies, there are no monthly payments or interest rates to worry about, and qualification standards are more flexible. It may be right for a homeowner with poor credit, high amounts of debt, or inconsistent income who has built up equity over the years.
• Home equity credit cards: There’s a secured loan tool that acts like a credit card, but has a lower interest rate and a larger limit by using home’s equity as collateral for the credit card. It’s generally much faster to get the home equity credit card funded than it is to wait for a home equity loan to close. 
• Personal loans: With a personal loan, you borrow a lump sum upfront and pay it back in installments. Lenders consider your income, debt, credit score, amount, length of the loan, and interest rates when qualifying you for the loan. The interest rate is usually higher and loan amounts are typically lower than a home equity loan. 
• Cash-out refinance: A cash-out refinance is a new mortgage that replaces your old mortgage with a new loan amount, new term, and new interest rate. The new mortgage will pay off your old mortgage, plus extra that you receive in cash. 

Disclosure: Some lending partners that participate in Credible’s comparison marketplace offer loans to borrowers with scores as low as 550. Borrowers with low scores will have fewer lending options than borrowers with higher credit scores.