Home prices have appreciated, but some homeowners are finding it difficult to tap their equity due to bad credit. Many home loan options, including cash-out refinance and HELOCs, typically require that homeowners have good credit in order to be eligible. If you have bad credit, don’t give up hope on accessing your home equity to get the money you need. Learn more about your home equity loan options, how to qualify, and alternatives you should consider.
What is a home equity loan?
A home equity loan is a fixed-rate term loan that’s backed by your home’s equity. These loans typically offer lower rates than personal loans or credit cards because they are secured by your home. However, they generally have shorter repayment terms than a mortgage, with terms ranging from 10 to 30 years. Having a shorter loan term can lead to higher monthly payments, which can make home equity loans less affordable than a mortgage payment of a similar amount.
Challenges of getting a home equity loan with bad credit
Your credit history is an indication of the risk a lender takes when lending you money. It captures your propensity to make payments on time, avoid getting into too much debt, and other positive money behaviors. When you have bad credit, lenders often charge higher interest rates and fees. In some cases, you may not be approved at all.
Traditional lenders often shy away from lending to customers with bad credit. Homeowners with bad credit who want to tap their home equity often have to turn to alternative lenders, private loans, and other subprime financing. Generally, these loans tend to have higher interest rates and fees. These unfavorable terms and conditions can make your financial situation even worse, especially if you are having trouble making your payments on time.
Qualifying for a guaranteed home equity loan with bad credit
To encourage homeownership for everyone, the Federal government guarantees some types of loans. The backing of the Federal government gives banks, credit unions, and other lenders the confidence to lend to borrowers with bad credit or a thin credit history. However, government-backed loans tend to concentrate on first mortgages rather than home equity loans or HELOCs. These guarantees encourage people to buy homes but don't give them that same backing to pull cash from their equity.
These loans often have different criteria for approval than a traditional loan. Some of these features make guaranteed loans more restrictive, while others open up homeownership to more people. FHA, USDA, and VA loans require that the home be in a certain condition for loan approval, while conventional loans do not. For example, the appraiser for an FHA loan must validate that the kitchen is in working order.
FHA, USDA, and VA loans also make buying a home more accessible. Loans backed by the Federal government tend to have lower interest rates, fees, and credit score requirements than these borrowers could normally qualify for without those guarantees. They also tend to have smaller down payment requirements, which reduces the amount a homebuyer must save before qualifying to buy a home. Lower credit score requirements make them an ideal choice for borrowers with bad credit.
Finding lenders and comparing options
Finding lenders that specialize in borrowers with bad credit can be challenging. Traditional banks often avoid riskier loans and focus on applicants with Good to Excellent credit. However, numerous lenders lend to borrowers with bad credit or a thin credit profile.
Finding lenders catering to bad credit
If your credit score is too low for your local bank, there are other lenders that focus on bad credit borrowers. While some of these lenders are predatory, there are others who are reputable.
- Start with your existing bank: Talk to a banker or loan officer to find out if you qualify. Banks may be more willing to lend to existing customers with a good track record of deposits and payments.
- Talk to a credit union: Credit unions are non-profit financial institutions. They tend to have lower credit criteria and more favorable terms than banks.
- Ask for referrals: Talk to friends and family who are in a similar financial situation. They may have a referral for a home equity loan, or they can share stories of banks to stay away from.
- Look for community lenders: Community organizations that help people with financial issues can recommend lenders specializing in borrowers with bad credit. They may also offer free or low-cost education to learn how to boost your credit before submitting your application.
- Online comparison site:. Many online sites allow visitors to submit their basic information to receive quotes from prospective lenders. Be careful with sharing too much personal information until you've chosen a lender.
Factors to consider when choosing a lender
Borrowers have many options when choosing a lender. Aside from getting a good interest rate and low fees, there are other factors you should consider.
- Other products available: It is often easier if you can have multiple products at the same financial institution. For example, you may be able to have your checking, savings, and credit card at the same bank as your home equity loan. This allows you to see all of your accounts in one place and easily transfer money between accounts.
- Ease of use: Does the lender have a website and mobile app? Online access makes it easy to view your loan history, make payments, and download statements.
- Reputation: What is the reputation of the lender? Are they fair to customers and provide good customer service?
- Locations and customer service: Does the lender have local offices where you can speak to someone in person? What are their customer service hours if you have a question about your account?
- Extra fees: What fees does the lender charge? Are these fees reasonable?
Comparing loan rates and terms
Before choosing a lender, it is important to compare interest rates, fees and repayment terms for each loan option. Many borrowers focus on the interest rate, but this doesn't factor in the fees that the lender charges. Instead, compare the APR among lenders to get an apples-to-apples comparison.
Also, look at the repayment terms. Getting a longer-term loan reduces your monthly payment amount, but it also leads to higher overall interest costs. Determine whether the interest rate is fixed or variable and if the payment includes both interest and principal. While an interest-only loan has lower monthly payments, the balance owed won't decrease unless you pay extra.
How to access your home equity with bad credit
Even if you have bad credit, you have options for drawing on the equity in your home. These are some of the most common loan types to choose from.
- Home equity loan: Home equity loans from traditional banks and lenders typically require credit scores of at least 680. However, some lenders may accept lower credit scores based on your income, loan-to-value and other factors.
- Reverse mortgage: A reverse mortgage is a way for qualified seniors to access their home's equity without requiring monthly payments. Borrowers receive a lump sum, stream of payments or access to a line of credit. These loans typically have higher fees than a traditional mortgage, and the loan comes due if the borrower moves out of the home for an extended period of time.
- FHA loans: A loan program for first-time homebuyers and those with small down payments. These government-backed loans allow credit scores as low as 500. The FHA also offers cash-out refinance options to access your home equity.
- VA loans: These loans are for eligible members of the military, veterans and surviving spouses. Down payments are as low as 0%, and interest rates and fees are competitive. Qualified borrowers can also perform a cash-out refinance through the VA loan program..
- Subprime loans: Subprime lenders specialize in lending to borrowers with bad credit. These loans tend to have higher rates and fees, but you can do a cash-out refinance with credit scores as low as 500. Borrowers often refinance once their credit score is high enough to qualify for another type of loan.
- Private loans: A private loan is made by one or more individual investors for buying a home or to do a cash-out refinance. These loans typically charge higher interest rates and fees. In some cases, they have a short duration that encourages borrowers to refinance as soon as their credit improves.
Explore alternatives to home equity loans
Depending on your situation, you may be better off exploring home equity loan alternatives. These financing options may offer better rates, lower fees or more favorable repayment terms.
A reserve mortgage is available for borrowers aged 62 and older. These loans tap into your home equity by providing a lump sum of cash, monthly deposits or a line of credit without requiring monthly payments. When you die or move out of the home for an extended period of time, the lender typically takes over the home to repay the debt. These loans often have higher interest rates and fees than a traditional mortgage.
Homeowners can get cash from their homes by doing a cash-out refinance. However, if they have bad credit, finding favorable rates, fees and terms may be a challenge. Before pursuing a cash-out refinance, ensure that the benefits outweigh the costs. A cash-out refinance is often a better choice after you’ve improved your credit score.
Home Equity Investment (HEI)
Point offers a Home Equity Investment where homeowners with a wide range of credit scores can get access to their equity without monthly payments. There are no income requirements, and you don't need perfect credit to qualify. In exchange for an upfront lump sum of cash, homeowners share in their home’s appreciation with Point.
A personal loan is an unsecured loan that doesn’t involve your home or its equity. Many banks, credit unions and other lenders offer personal loans for borrowers with bad credit. Repayment terms are usually two to five years, depending on the lender and how much you borrow. Since these loans are unsecured, the interest rates also tend to be higher than a mortgage.
Carrying a balance on a credit card typically results in high-interest charges. However, you may be able to take advantage of a 0% intro APR offer on purchases or balance transfers when getting a new credit card. Lenders offer credit cards for a variety of credit types, including those with bad credit. Make sure that you pay off the balance before the intro period expires. Any remaining balance at the end of the intro rate becomes subject to the card’s standard APRs, which can exceed 30%.
If you have bad credit and want to access your home's equity, you have options. While you may not qualify for a traditional second mortgage through your bank, other lenders can provide financing on your home. You'll find numerous lenders by asking for referrals from friends, community organizations, and online searches. Before applying for a home equity loan, evaluate each lender carefully and compare loan rates, fees, and terms. Then, choose the option that meets your financial needs and offers a payment that fits your monthly budget.