HELOC with bad credit: Utilizing home equity

Rising interest rates and persistent inflation have made it difficult for many Americans to keep up with their expenses. Luckily for homeowners, they can tap into their home equity through a HELOC, or home equity line of credit. 

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HELOCs allow homeowners to tap into the equity they’ve accumulated in their properties and use these funds to pay off major expenses. It’s advised to use a HELOC to consolidate high-interest debt, make home renovations, or pay for a child’s college tuition. However, the money can be used for a variety of purposes. 

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Lenders usually approve HELOCs for consumers with a strong credit history. However, having a lower credit score doesn’t necessarily mean you can't qualify for a home equity line of credit. Here’s what you need to know about obtaining a HELOC with bad credit. 

How does a HELOC work?

A home equity line of credit (HELOC) works similarly to a credit card in that it provides the borrower with a revolving line of credit. HELOCs usually include a credit limit and a "draw period," a predetermined time frame during which you can access this line of credit. You can continuously borrow against available funds as long as you stay within your credit limit and pay interest on the HELOC.

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Unlike unsecured credit options like credit cards and personal loans, a HELOC is secured by the equity in your home in the same way that home equity loans are. As a result, defaulting on a HELOC puts you at risk of losing your home.

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Since your home serves as collateral for the loan, lenders face less risk, enabling them to offer lower interest rates compared to other loan types. This makes a HELOC an attractive financing option for homeowners who want to keep their borrowing costs to a minimum. A HELOC may also come with better repayment terms than other types of financing. 

Understanding bad credit

Applying for any kind of financing, including a mortgage, car loan, or credit card, can be difficult with a credit score below 670. A borrower with bad credit may get their financing request approved, but they will likely be approved for a lower credit limit and a higher interest rate. 

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Lenders use two types of scoring models to assess credit: the FICO score and the VantageScore. Although both systems evaluate credit on a scale from 300 to 850, each model operates slightly differently.

FICO Score

Lenders use a borrower’s FICO score to determine the probability of the borrower repaying a loan. Should your credit score fall within the 300–579 range, it would be classified as poor, potentially causing lenders to perceive you as a high-risk borrower. 

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Here’s how the FICO credit scoring system ranks credit scores: 

• Poor: 300-579
• Fair: 580-669
• Good: 670-739
• Very Good: 740-799
• Exceptional: 800-850

VantageScore

VantageScore represents an additional credit scoring model that utilizes consumer credit reports to generate credit scores. Within the VantageScore model, a credit score between 300 and 660 is categorized as ‘poor.’ 

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Here’s how the VantageScore model ranks credit scores:

• Very Poor: 300-499
• Poor: 500-600
• Fair: 601-660
• Good: 661-780
• Excellent: 781-850

Factors that impact your credit score

Your credit score is determined by the data contained in your credit report, which is compiled by the three major credit bureaus: Equifax, Experian, and TransUnion. These bureaus create individualized credit reports based on the utilization of different credit accounts under your name. The FICO model considers the following five factors when calculating your credit score:

• Payment history (35 percent): Arguably, the most important factor contributing to your credit score is whether or not you pay back your debt and if you pay it back on time. 
• Credit utilization (30 percent): The second most important factor is your debt-to-credit ratio which is the difference between how much you owe and the amount of credit available to you. Lowering your credit utilization ratio helps boost your credit score. 
• Credit history (15 percent): Lenders also take into account the length of your credit history, which is essentially how long you’ve been able to successfully maintain healthy credit accounts. 
• Credit mix (10 percent): Lenders like to see a mix of credit, meaning you’re not just paying off credit cards, but also car loans, student loans, and other forms of financing. 
• Credit applications (10 percent): How often you apply for new lines of credit also impacts your credit score. Borrowers who are constantly applying for new credit may be considered high risk by lenders. 

How your credit score impacts a HELOC application

When applying for a HELOC, it's important to keep in mind that each lender sets its own standards for minimum credit scores and other factors. However, FICO scores generally affect your chances of being approved for a HELOC in the following ways: 

• 760 and above: Applicants may qualify for credit at the best rates.
• 700 to 759: Applicants are likely to qualify for the credit, but not at the best rates.
• 621 to 699: Applicants may find it difficult to qualify for a HELOC with fair credit and are likely to pay higher rates.‍
• 620 and below: Applicants are likely to have trouble qualifying for a HELOC with bad credit, regardless of the rates offered.

Can you get a HELOC with a low credit score?

Whether or not you get approved for a HELOC depends on a variety of factors. Your credit score is not the only determinant. Lenders take into account additional considerations such as the amount of equity in your home, loan-to-value ratios, and existing debt levels. 

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However, a borrower's credit score will heavily influence the interest rate at which a HELOC is approved. Therefore, while you could get approved for the amount you need, it may come at a higher cost due to poor credit. If you have bad credit but want to increase your chances of getting approved for a HELOC, here’s what you need to know:

Have enough home equity

The first thing you should consider is the amount of equity you have accumulated in your home. Equity is the difference between how much your home is worth and how much you owe on your mortgage. You build equity through steady mortgage payments and home appreciation. Borrowers need to own a minimum of 15%-20% equity in their home to get approved for a HELOC. This usually means you will have to have owned the property for a certain amount of time. For most homeowners, it takes about five to ten years to build 15%-20% equity in their homes. 

Check your credit report

A minimum credit score of 670 is necessary in order to obtain a HELOC at a reasonable interest rate. As mentioned above, the minimum credit score requirement for a HELOC varies by lender, but your credit score will still impact the rate at which you’re able to borrow. You can check your FICO Score and VantageScore with any of the major bureaus: Experian, Equifax, or TransUnion. By reviewing your credit reports, you can identify and dispute any errors to improve your score.

Calculate your DTI

Lenders look at your debt-to-income ratio (DTI) when determining if you can afford to pay back a HELOC. To find out your DTI ratio simply divide your monthly debt payments by your gross monthly income. A maximum debt-to-income ratio of 43% is recommended, although some lenders will accept as high as 50%. 

Consider a co-signer

If your credit score is poor or very poor, you may not be able to get approved for a HELOC independently. Instead, you’ll need to bring on a co-signer with a higher credit score. A co-signer is essentially a third party who assumes equal responsibility for the loan with you. It’s best to ask someone close to you, such as a family member, to cosign for you.