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A home can be a place of safety, comfort and wonderful memories. But your home — or, rather, the equity you’ve built up in your home — can also be a powerful asset that you can tap in times of financial need.

Your equity is the difference between the money you owe on your home and the home’s value. It increases in two primary ways: as you pay down your mortgage, and as your property becomes worth more.

You can use this equity as collateral for a loan — borrowing money to make home improvements, send a child to college, consolidate high-interest credit card debts, pay for emergency medical expenses, or to create a reserve fund for a future purchase.

Many borrowers access their equity with a home equity loan or a home equity line of credit. But even if you have bad credit, you may be able to qualify for a home equity loan or line of credit, although you likely won’t get as good an interest rate as someone with excellent credit.

In this guide, we’ll cover:


A quick guide to home equity loans and home equity lines of credit

Home equity loans and home equity lines of credit are often called second mortgages. That’s because they take a “second position” to your first mortgage.

They come with the same responsibilities as a first mortgage, and your home equity is the collateral for the second mortgage, as well as the first. If you miss a payment on either, you could lose your home to foreclosure.

There are some important differences between home equity loans and home equity lines of credit, which you’ll need to know to determine which is the best option for you.

Home equity loans (HEL)

You borrow a lump-sum amount based on the equity in your home. The loan is paid back like a first mortgage, with fixed payments of principal and interest in terms typically ranging from five to 20 years.

Home equity line of credit (HELOC)

A home equity line of credit works like a credit card, at least at first. Your lender sets a credit limit based on the equity in your home, and you can borrow against that limit at any point while the line of credit it still open, typically five to 10 years.

During this initial period, commonly called the “draw period,” you can charge up the balance and pay it to zero as often as you wish. The payments during the draw period are usually interest-only, making the minimum payment very low for any balance that is charged.

After the initial draw period ends, the remainder of the balance needs to be paid off on a fixed payment schedule that you agree to with your lender. Usually you have between 10 and 20 years to repay the entire loan.

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Pros and cons of a home equity loan

Pros

  • As with a mortgage, your interest payments may be tax deductible for qualified expenses. As of Dec. 15, 2017, interest paid on a home equity loan is only tax deductible if the money is used for home improvements, so be aware if you are planning to use the funds for any other expenses, like paying off debt or to cover a child’s college tuition.
  • Home equity loans also typically have a fixed interest rate, so you’ll know exactly how much your monthly payments will be and when you’ll pay off the loan. Generally, the terms are around five to 20 years, although some lenders may offer longer terms.
  • A home equity loan could be best for a one-time expense because you’ll receive a single disbursement and then pay off the debt over time.

Cons

  • When you take out a home equity loan, you’re putting your home at risk if you find yourself in a financial emergency and can’t afford to make your monthly payments.
  • If you sell your home, you may not net as much because the balance of the home equity loan will reduce your sale proceeds.
  • If you have bad credit, your interest rate and total payment will be significantly higher.
  • You are committing to a long-term fixed payment debt.
  • You’ll have two mortgage payments instead of one.

Pros and cons of a home equity line of credit (HELOC)

Pros

  • HELOCs have a long draw period, often around five to 10 years, during which you can borrow against the credit line.
  • During the draw period, your payments are often interest-only, which will help you keep a low monthly payment.
  • You can pay the balance to zero as often as you wish during the draw period, and the payment is only based on the amount you charge.
  • Some lenders may allow you to lock in the rate during the draw period to avoid increases and decreases.

Cons

  • Because HELOCs have variable interest rates, your monthly payment amount on the balance drawn could change frequently.
  • You may have to withdraw a minimum amount when you first open the line of credit, and there could be minimums on future draws.
  • If you sell your home, you’ll need to pay any remaining debt from a HELOC.
  • There could be a significant increase in the monthly payment once the draw period ends, because the remaining balance is required to be paid on a set payment schedule similar to a home equity loan.
  • You’ll have two mortgage payments instead of one.

Home Equity Loan HELOC
Best for A large one-time expense, like debt consolidation or a kitchen remodel. Ongoing projects that don’t have a set cost, like a big home improvement project or college education.
How it works You’ll receive one lump sum to use as you wish. You’ll have a monthly payment until the loan is paid in full. Your lender will give you a debit card or checks tied to your account; anytime you want to draw on your HELOC, you simply use it to pay as you go.

You’ll have to pay monthly interest-only charges during your ‘draw period’.

Time frame to recieve cash Varies by lender. Generally, it could take two to six weeks from when you submit your application to get your loan. Varies by lender. It could take two to six weeks from when you submit your application to your first credit line draw.
Repayment term Five to 30 years, varies by lender. Typically 10 to 20 years after the end of your draw period.
Borrowing limits May range from $10,000 to over $1 million, depending on the lender, state, your equity, credit, debt, and income. Your line of credit could be over $1 million, depending on the lender, the state, and your equity, credit, debt, and income. There may be a minimum initial draw requirement, and you could subsequently have to draw at least $500 or more.

What it takes to qualify for a home equity loan

How much equity you’ll need

You’ll need a significant amount of equity in your home to qualify for a home equity loan or HELOC — and you won’t be able to borrow all of it.

There are two calculations a lender will use when determining how much equity you can borrow for a home equity loan or HELOC. The first is loan-to-value (LTV), which is determined by dividing your current first mortgage loan balance by your home’s value.

The second calculation is combined-loan-to-value (CLTV) and is determined by dividing the balance of both your current first and potential new second mortgage balance into your home’s value. CLTV determines the maximum you’ll be able to borrow on your home equity line of credit or HELOC.

Although there are programs that will allow you to borrow up to the entire value of your home, you’ll most likely be limited to 80% or 90% if you have bad credit with scores down to 620. Non-prime lending programs are available for scores below 620, but the lower your scores are, the less equity you’re likely to have access to.

A low debt-to-income (DTI) ratio

Home equity lenders will want you to have a DTI below 43% after taking into account the potential new loan. This is especially true if you have bad credit, since DTI is the most important factor an underwriter uses when evaluating your ability to repay a loan besides your credit.

To calculate your DTI, add up all your monthly credit obligations — including mortgage, auto, and credit card payments — and divide the sum by your monthly income (or use this handy calculator).

Good credit payment history

Besides credit scores themselves, lenders will also look at your credit payment history, especially the past 24 months. If you have had a lot of late payments in a fairly recent period, home equity lenders may not approve you even if your scores meet the minimum requirements.

They may be concerned that your financial situation is deteriorating, and because they are taking a second position to your current mortgage, they are in a weaker position to recoup their money in foreclosure in the event you default.

However, if the purpose of taking out the home equity loan or HELOC is to improve your credit by paying off high interest credit cards, or consolidating multiple debts into one payment, you may still get approved.

Major credit events may be OK

If you have a past bankruptcy or foreclosure, you may have trouble qualifying depending on how long it’s been since the bankruptcy was discharged, or the trustee’s sale was completed on a foreclosure.

Home equity lenders may have their own time frames and rules, and you may be eligible for a home equity loan or HELOC sooner if you’ve rebuilt your credit and there were extenuating circumstances that led to the bankruptcy or foreclosure.

Shopping for a home equity loan or HELOC when you have bad credit

Even if you have poor credit, you can qualify for a home equity loan or HELOC if you have a significant amount of equity in your home. Whether you’re looking for a home equity loan or a HELOC, lenders have a set of guidelines you’ll need to meet to qualify.

What is a “bad credit” score for a home equity loan or HELOC?

Some home equity lenders specialize in products for borrowers with bad credit, while others only offer home equity loans for borrowers with high credit scores. Here’s a brief overview of what to expect.

620 and below: A 620 score is typically the minimum credit score for conventional first mortgages, but with second mortgages this score will make it much harder to borrow money. You’ll need to have more income compared to your debt (called your debt-to-income ratio or DTI) and you won’t be able to borrow as much equity.

621 to 699: There will be more options for you to consider, and you may be able to access more equity. However, rates will be higher, and you won’t be able to access as much equity as you can with higher scores.

700-759: This credit range will generally get you the maximum amount, but still not at the best rates possible.

760 and up: Credit scores in this range will allow for the best rates and terms possible for a home equity loan or HELOC, and allow you to access the maximum amount of equity.

Shopping tips for home equity loans and HELOCs

Don’t let your poor credit score deter you from aggressively comparing offers for home equity loan or HELOCs. Check out our home equity loan comparison tool, which allows you to compare rates easily online.

You may need to shop around more to find a lender, and be prepared to provide much more documentation than you otherwise might, as well as explanations for your current credit situation. Don’t ever pay money upfront to be prequalified for a home equity loan or HELOC.

One important thing to note: HELOC lenders are not required to provide disclosures under the Truth in Lending Disclosure Act guidelines that went into effect in 2015, which means you may or not receive a loan estimate. Be sure to get an itemized fee sheet or something in writing from any home equity line of credit lender to make sure you know what the fees are before you apply.

Where to shop for a bad credit home equity loan or home equity line of credit

When you bought your home, you may have used the services of a mortgage broker, your realtor’s preferred mortgage banker, or an institutional bank. While they may be great sources for the best rates and terms on a first mortgage like the one you took out to buy your home, they may not have as many options for home equity lending, especially if you have low credit scores.

Online digital comparison lender sites

If you have a low credit score, it may be more difficult to find a home equity loan or HELOC. Online comparison lenders may provide you with several options based on the information you input.

Rather than waiting on the phone for a loan officer to determine if you qualify, you can input the information into the comparison tool, and receive several options that have already filtered your information based on your credit score. This can save you time and frustration, and give you an idea of what types of terms you’re likely to be offered with your present credit situation.

Many online lenders have digital loan approval processes, which result in a very quick turnaround to get you approved, or to at least let you know where you stand in the home equity lending world.

Traditional banks and institutional lending

You may also want to start by going to your local bank or credit union. They tend to offer competitive rates and terms to existing banking customers, especially if you have a large deposit balance, or have other credit accounts with them already, like car loans and credit cards.

The only drawback is they usually have more stringent underwriting guidelines, and may not approve you for a home equity loan if your credit scores fall below their minimum requirements.

Mortgage brokers and mortgage banks

Mortgage brokers and banks may offer home equity loans and HELOC products, but they tend to have a limited product line and specialize more in first mortgages. Very often they will refer you to an online lender, or suggest you speak to your local credit union or bank.

Non-prime home equity lenders

Non-prime lenders, or alternative lenders as they are also called, may provide you with home equity loan options with credit histories traditional lenders won’t lend on. Be sure you understand all the terms of the loans, and expect high interest rates, and much lower combined-loan-to-value requirements.

What’s new in 2019 for home equity loans and HELOCS with bad credit

The mortgage lending world is expanding in 2019 to include options for more borrowers, including more second mortgage options for borrowers with bad credit. Below are new options that may be available to you in 2019.

Home equity loans for “non-prime” customers, down to a credit score of 500 score

Don’t confuse non-prime loans with the subprime loans of the housing crisis. “Non-prime” is a reference to lenders that provide funding options outside of the traditional lending world.

Mortgage lenders are subject to supervision by the Consumer Finance Protection Bureau, and even if they offer high interest rate loans with lower credit score requirements, they still have to show that you have the ability to repay the loan. As home equity has increased, non-prime lenders have begun to offer programs that give you access to equity, even if your scores are below the minimums normally associated with home equity loans and HELOCs.

Longer loan terms

Home equity loan periods have generally been capped at 15 to 20 years, but banks, credit unions and smaller home-equity-only companies have begun offering periods as long as 30 years. This is especially beneficial if you have poor credit, since the higher interest rate can be spread out over a longer time period, resulting in a lower payment.

Higher loan-to-value home equity loans

The loan-to-value ratio is a measure of how much your mortgage balance is compared to the value of your home. Most lenders will only allow you to borrow against your home equity until your first and second mortgages combined reach an 85% LTV ratio. If your scores are on the lower end of the credit spectrum, you’ll be restricted to how much equity you can borrow. However, if you can increase your scores, you’ll benefit by now being able to borrow up to 100% of the value of your home.

Digital home equity lenders

You’ve probably heard about digital mortgages, with their promise of faster turn times, less documentation and in some cases no appraisal requirement. Digital home equity lenders are now entering the market, offering the potential to close a home equity loan in less than 14 days with very little documentation and an appraisal that only requires a driveby.

A full home appraisal for a mortgage requires interior pictures and a more involved analysis of comparables in your area. A driveby often involves little more than a picture of the outside of your home, to confirm it appears to be in good condition, and may cost significantly less than the $300 to $400 — or potentially even higher — that you might pay for a full uniform residential appraisal report.

Providing the documents you’ll need for a home equity loan or HELOC approval

Once you’ve determined which option to move forward with, you’ll need to gather your documents. The application process is similar to applying for a mortgage, and you’ll need:

  • Your name and Social Security number, and a photo ID.
  • Personal information for a co-applicant or spouse.
  • Proof of employment and income.
  • Recent tax returns (most likely the last two years worth of federal tax forms).
  • Homeowner’s insurance policies.
  • An estimated property value and property tax amounts.
  • Bank statements for the last two months, including all pages of each statement
  • Information about other properties or assets you own including mortgage statements, property taxes, homeowners insurance and any homeowners association dues that might be applicable.

After you submit your application, it will be sent through processing and underwriting. A mortgage loan processor verifies all the information you provided on your loan application, and an underwriter analyzes it to confirm it meets the lender guidelines to approve or deny your request.

FAQs about home equity loans and HELOCs

What fees should I know about?

Like any home loan, there are fees related to home equity loans and HELOCs.

HELOCs generally don’t have closing costs, but you may have to pay an annual fee, an inactivity fee or an early-termination fee, if you decide to close the credit line early. You may be able to avoid the termination fee if you pay the line of credit down to a zero balance, and keep it open for future use.

Home equity loans may have closing costs, fees for obtaining your credit reports or hiring an appraiser and a prepayment penalty. There also may be underwriting or processing fees related to the approval of your loan. They should be disclosed on a standard loan estimate form like you received when you obtained your first mortgage.

You may also be able to get a lower interest rate and some of the fees waived, including a HELOC’s annual fee, by maintaining a checking account with the lender, if they also offer deposit services (as a bank or credit union might).

How important is your credit score?

Your credit score plays a crucial role in your ability to get a home equity loan and the terms you’re offered. A low score could result in a higher interest rate and fewer loan options.

FICO maintains a chart with the average annual percentage rate (APR) and monthly payments on 10-year home equity loans, 15-year home equity loans and HELOCs, depending on an applicant’s credit score.

At the time of this writing, someone with a credit score between 620 and 639 could borrow $50,000 on a 15-year home equity loan at an APR of 11.28% with a payment of $577 per month. The same loan for people with credit scores between 740 and 850 would feature a 6.955% APR and a monthly payment of $448 — a difference of 4.325% with savings of nearly $130.

The chart below shows the effects of a low FICO score on your payment for a HELOC and a 15-year home equity loan.

How Home Equity Loan Payments Change Based on Credit Score
FICO Score HELOC APR HELOC payment 15-year HEL

APR

15-year HEL

payment

740-850 6.598% $319 6.955% $448
720-739 6.973% $332 7.255% $457
700-719 8.223% $375 7.755% $471
670-699 9.598% $424 8.530% $493
640-669 11.098% $480 10.030% $538
620-639 12.598% $537 11.280% $577

*These APRs assume an 80% Loan-to-Value Ratio. They also assume a single family, owner-occupied property used as collateral. Based on data effective March 14th, at My FICO Home Equity Center

If you want to improve your credit score to better your odds of qualifying for a home equity loan, there are some simple steps you can take — start by knowing where you stand. You can check your credit score for free on LendingTree.com, and follow some best practices to improve your score over time.

You should also review your credit reports for inaccurate information. If there are mistakes on your reports, you can send a dispute to the credit bureau and ask for the inaccurate information to be removed. You might see a quick boost in your score.

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How much can you borrow with a home equity loan?

You may have a specific use for the money in mind when applying for a home equity loan. How much you can actually borrow depends on several factors.

Your LTV plays an important role in determining your borrowing limit. For example, if your home is worth $100,000 and you have a $70,000 mortgage — your LTV in this case is 70% (you divide $70,000 by $100,000 to determine this). For the sake of this example, let’s assume the lender allows you to borrow a total of 90% of combined loan to value.

Ninety percent of your $100,000 home value is $90,000. To determine the dollar amount you could access, you would subtract your current loan balance of $70,000 from $90,000, which equals $20,000. You could effectively borrow $20,000 with a home equity loan or a home equity line of credit, bringing your total loan balance to 90% percent of the home’s value.

Your credit score and DTI play a very large role in the maximum you can borrow for either a home equity loan or a HELOC. The lower your credit score, the less a home equity lender will be willing to loan you.

The same is true of DTI, especially if your credit scores are low. Lenders may even require a lower DTI, if your credit scores are on the lower end of the range outlined earlier in this article.

Risks when taking out a home equity loan

While a home equity loan may seem like a good way to quickly access a large amount of cash, it’s not always the best option. By putting up your home as collateral, you risk losing your home if you can’t afford a payment.

Some uses for the money may also be better than others. For example, taking out a home equity loan to remodel, repair or expand your home could add to the home’s value.

Using your home’s equity to consolidate unsecured debts, such as credit cards, can save you money on interest and improve your credit score because you’ll lower your utilization rate. However, you’re also transferring unsecured debts to a secured debt, and converting short term debt into longer term debt depending on the term of the loan you choose.

Alternatives to a home equity loan

If you decide against a home equity loan or don’t like the terms you’re being offered, you could still turn to other sources for funding.

Cash-out refinance

With a cash-out refinance, you borrow more than you owe on your current mortgage and keep the extra funds as cash. It may be a simpler process, and you’ll only have one mortgage payment each month.

Total costs on a cash-out refinance may be higher because you’re increasing the size of your first mortgage. However, cash-out loan programs like the FHA loan will allow you to borrow up to 85% of your home’s value with a credit score as low as 580, which gives you added options if your scores are below the 620 threshold that most home equity lenders require as the minimum.

Personal loan

A personal loan lets you borrow money without putting up any collateral. Some lenders may have a lower required credit score for a personal loan (perhaps around 580 or 600) than what you might need for a home equity loan.

However, the interest rate could also be more than 35 percent — even higher than a credit card. But if you don’t have a credit card and don’t want to risk losing your home, a personal loan may be worth considering.

Other options

If you own a car or boat with no loans on them, you may be able to get a title loan to raise cash, although the terms are likely to be very expensive. Like any secured loan, you risk losing the collateral (your boat or car) if you are unable to make payments.

If you have assets like a 401k, you may want to consider a 401k loan, or you can access funds from retirement accounts, taking into consideration the potential tax consequences of doing so.

Final thoughts about getting a home equity loan or HELOC with bad credit

As more non-prime lenders enter the mortgage market, there are likely to be more programs that allow you to borrow more equity with lower credit scores and higher DTIs. As such, it’s important to remember a few things about home equity loans and HELOCS.

First, the debt that is being created is secured against a home, which provides shelter for homeowners and their families. Defaulting on that debt could create instability if the lender forecloses on a home due to nonpayment.

Second, it’s always best to minimize borrowing against equity that’s been built in a home, especially if the terms of the loan are likely to be expensive due to bad credit. The ultimate goal of homeownership should be to ultimately own the home debt free, providing a cheap source of shelter for the current homeowner, and a source of wealth to pass on to family members as a part of a financial legacy.

This article contains links to MagnifyMoney, a subsidiary of LendingTree.

 

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