Breaking the credit barrier: How to get a home equity loan with bad credit

Home equity loans are a common equity product backed by property as collateral. They come with lower interest rates, making these kinds of loans more favorable to the borrower and less risky for the lender.

Securing a home equity loan with a low credit score can be difficult. Even with a large amount of equity in your home, lenders will hesitate to approve an equity line with bad credit. Luckily, there are ways around this.

Homeowners who don’t qualify for traditional home equity loans can explore alternative financing through home equity investments or pursue a home equity loan with lenders who are more lenient with credit scores.

Can I get a home equity loan with bad credit?

You can obtain a home equity loan with bad credit—it just won’t be as easy as if you had a high credit score. You may also be restricted in terms of loan amounts.

Home equity lenders have different borrowing criteria, but the requirements are usually a minimum credit score of 620, owning at least 15%- 20% of your home’s equity, and a maximum debt-to-income ratio of 50%. The vast majority of lenders will also look for an on-time bill payment history and stable employment/income.

However, because your entire financial profile is being evaluated—not just your credit—having a low credit score can be outweighed by other factors. Qualifying for a home equity loan with bad credit is possible if you:

• Own a high percentage of equity in the home.
• Have a monthly income that is substantially higher than what is required for the loan.  
• Have a very low debt-to-income (DTI) ratio.

How to qualify for a home equity loan with bad credit

Check your credit report

Pull your credit report from the three major credit bureaus—Equifax, Experian, and TransUnion—to look for errors or discrepancies you should dispute.

If you can't improve your credit before applying, be sure to protect it from dropping lower. Continue to pay your bills on time every month, avoid hard pulls on your credit, and avoid racking up debt.

Alternatively, if you have the time, a few actions you can take to raise your credit score are:

• Paying down your debt balances
• Becoming an authorized user on a separate account with a high credit limit
• Reporting rent and utility payments

Have enough home equity

Equity is essentially the ‘amount of house you own’ that doesn’t belong to the bank. As mentioned before, you would need to own at least 15%-20% of the equity in your home. Additionally, lenders require that you maintain at least 15% of your home’s equity after taking out a home equity loan.

Lenders typically allow you to take out a maximum of 85% of your home’s property value. Your equity level and combined loan-to-value (CLTV) ratio will ultimately determine how much you can actually borrow. The combined loan-to-value ratio (CLTV) is calculated by dividing the total loan amount (including existing and potential new loans) by the property's appraised value.

To strengthen your application, you should own a significant amount of equity. You can increase your equity by:

• Making small—but impactful—home improvements around the property. Think budget-friendly projects with a solid return on investment (ROI)!
• Paying off more of your mortgage balance, whether in a lump sum or through extra payments here and there.
• Timing out the marketing for a period when home values are high.  

Calculate your DTI

Lenders use your debt-to-income ratio (DTI) to gauge how much of your monthly income is going to debt—and whether you can afford to take on more. To determine your DTI ratio, divide your monthly debt payments by your gross monthly income.

If you make $7,500 a month and have a $2,500 monthly mortgage payment and $500 in monthly student loan payments, you would use the following equation to determine your DTI ratio:

$2,500 + 500 / $7,500 x 100 = 40%

Lenders prefer a DTI ratio of 43% or less, although some do allow for a DTI of up to 50%. Be mindful of these percentages when taking out new debt, such as car loans and additional lines of credit.

Organize your financial documents

Having financial documentation in order will ease the process of applying for any type of loan. The more documentation you can gather, the better. Lenders will ask for different kinds of documentation, but they will all be looking for proof of income and assets. Your lender may ask to see a variety of documents, such as:

• Bank statements
• Tax returns
• Pay stubs
• W-2s

If you want to take out a home equity loan as a self-employed borrower, you’ll also need to supply:

• Two years' worth of personal and business tax returns
• Profit and loss statements
• Balance sheets
• Bank account statements

Consider a co-signer

If your credit is poor enough that you don’t qualify for a home equity loan on your own, a co-signer may be the next best option. A co-signer is essentially a third party who is just as responsible for the loan as you are. If you fall behind on monthly payments, their credit suffers along with yours. Cosigning is a major responsibility, so it's best to ask someone close to you, such as a relative.

Shop around

Different lenders offer varying terms, interest rates, and fees; some may be more accommodating of bad credit than others. By thoroughly researching and comparing your options, you can find a lender that offers the best possible deal for your financial situation. Look for lenders who specialize in working with individuals with less-than-perfect credit, and be sure to review their reputation and customer reviews.

Where to find a home equity loan with bad credit

There are several avenues to explore that can increase your chances of securing a loan:

• ‍Traditional banks: While traditional banks have stricter credit requirements, existing customers with good banking relationships may be given better opportunities. Wells Fargo, Bank of America, and Discover are reputable banks that give home equity loans with bad credit.‍
• Credit Unions: Credit unions often provide more personalized services and are more willing to work with bad credit members. Their community-focused approach could lead to better terms and lower fees.‍
• Online lenders: Online lenders are likely to approve a poor credit application. However, rates and fees will be far less competitive. Lenders provide a quick and convenient application process, with many offering pre-approvals within minutes and funding within days. Reputable lenders include Rocket Mortgage, Quicken Loans, and e-Mortgage.

Alternative financing options

If the cons of taking out a home equity loan with poor credit outweigh the pros, you may want to consider other options.

Home equity investment

For homeowners with less-than-perfect credit or non-traditional income, a home equity investment (HEI) is a worthwhile option to explore. An HEI allows homeowners with a 500+ credit score to access a lump sum of cash—with no restrictions on how the funds can be used, no monthly payments, and no income requirements—in exchange for a share of their home’s future appreciation.

Homeowners repay the HEI in a lump sum at any time during a flexible 30-year term, including when the house is sold, refinanced, or using another source of funds.

Reverse mortgage

Reverse mortgages are reserved for homeowners over the age of 62 who would like to tap into their home’s equity as a source of tax-free income. These loans must be repaid either when you pass or sell the home. They can be used for anything ranging from home renovations to medical expenses.

To qualify, owners need to own their home outright or at least have paid off the majority of its mortgage. A reverse mortgage makes sense if you’d like to have some extra income after retirement or if you don’t care about passing off your home to loved ones after your death.

Personal loan

Unsecured personal loans for borrowers with poor credit typically come with high-interest rates. But if a home equity loan isn’t an option for you or you don’t have collateral to borrow against, a personal loan can be a good way to secure financing. Personal loans allow you to prequalify without taking a credit hit, make fixed monthly payments, and receive funds in as little as 1 to 7 days.

Home equity line of credit (HELOC)

A HELOC works a bit like a credit card—but it’s secured by your home’s equity. Once you’re approved, you get a set credit limit you can borrow from as needed, whether it’s for debt consolidation, remodeling the kitchen, or covering unexpected expenses. You typically make interest-only payments at this stage, which helps keep monthly costs lower. After that, you enter the repayment period, where you’ll pay back what you’ve borrowed, plus interest.

HELOCs typically require a credit score above 620, which can make it difficult to qualify for if you have poor credit. However, it's still worth comparing lenders and prequalifying where possible.

Frequently asked questions

Can I get an equity loan with a 500 credit score?

It can be tough—a lot of lenders prefer scores in the mid-600s or higher. However, some specialized lenders or programs might work with lower scores, often at higher interest rates. You'll need to shop around and prequalify.

Why would a home equity loan be denied?

Home equity loan requirements vary by lender. However, you may be denied for a home equity loan if you have too little equity in your home, a low credit score, a high debt-to-income ratio, or issues with your home’s value or condition.

What is the downside of a home equity loan?

There are a few drawbacks: you’ll usually have to pay closing costs and fees, go through strict underwriting to prove income and creditworthiness, and get a home appraisal—which can all add time and expense to the process. Most notably, with your home as collateral, you risk foreclosure if you default.

The bottom line

Realizing you can’t take out a home equity loan due to bad credit can be incredibly disappointing. However, as you can see from the information shared above, there are several alternatives to securing home equity funds as a homeowner. Point provides a unique financing solution to homeowners with low credit scores who need home equity funds deployed efficiently and with maximum flexibility. 

Visit Point to find out if you qualify to fund your goals without new monthly payments.