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

Is bad credit making you feel out of options? Accessing home equity is an important financial asset for any homeowner — even those without a pristine credit score. It allows them to finance a much-needed home improvement project, pay unexpected expenses, or consolidate crippling debt.

Vivian Tejada
May 22, 2023
Updated:
June 4, 2024

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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 easy as if you had a high credit score. You may also be restricted in terms of loan amounts. Traditional lenders use credit scores to determine whether a borrower qualifies for a home equity loan, although some lenders are open to working with homeowners who have low credit scores. 

In a home equity loan, the borrower is usually required to have a large amount of equity in their home instead of a high credit score. Not all lenders utilize this method, so if you’re looking for a home equity loan for fair credit scores, you’ll have to shop around a bit.

How to qualify for a home equity loan with bad credit

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

Traditional home equity loans 

If you fall short of the requirements mentioned above, you can take a few actions to improve your chances of getting approved for a bad credit equity loan. Improving your credit score is the obvious place to start. Having a high credit score makes it easier to secure any kind of financing. A few actions you can take to raise your credit score are:

  • Resolving collection accounts
  • Paying down your balances
  • Disputing credit report errors
  • Becoming an authorized user on a separate account with a high credit limit
  • Reporting rent and utility payments

Although improving your credit score is always a good idea, it will likely take a few months. If you need to access the funds for time-sensitive expenses, the best thing to do is to explore alternative financing that might approve a home equity loan with poor credit. 

Alternative home equity loans

If none of the options mentioned above work for you, don’t give up hope just yet. Qualifying for a home equity loan with bad credit is sometimes possible if the borrower:

  • is willing to pay a higher interest rate 
  • has accumulated a certain percentage of equity in the home
  • has a monthly income that is substantially higher than what is required for the loan  

Depending on what you plan to do with the money you borrow, a higher interest rate may be worth it. Renovating your home, for example, may increase your home sale price and ultimately enhance your financial standing. However, if you’re taking out a home equity loan with the intention of consolidating debt, a higher interest rate may not make sense.

home-equity-loan-with-bad-credit

Below are five ways you can increase your chances of being approved for a home equity loan with poor credit:

Check your credit report

Pull your credit report from the three major credit bureaus—Equifax, Experian, and TransUnion—and make sure there are no errors or discrepancies on your report. Once you know where you stand, you can come up with a plan to improve your credit score, which may include paying bills on time every month, minimizing the amount of new lines of credit you take out, and keeping credit cards open even after you pay them off. 

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% to 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. This usually means that you will have had to have lived in the property for a certain amount of time. 

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.

Calculate your DTI

Lenders use your debt-to-income ratio (DTI) to determine if you can afford to take on more debt. 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 to 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

Consider a co-signer

Lastly, 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. 

Pros and cons of getting a home equity loan with bad credit

It’s important to weigh out the pros and cons of taking out a home equity loan with bad credit. Here are a few points to consider:

Pros 

  • Home equity loan rates are typically lower than rates on personal loans
  • Home equity loan funds are disbursed quickly and can be used for any financial reason
  • Interest paid on home equity loans may be tax-deductible if used for home renovation projects

Cons

  • Lenders can foreclose on your property if you fall behind on monthly payments
  • Low credit score loans often come with high-interest rates and monthly payments
  • Interest is not tax-deductible if used for debt consolidation

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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. Beyond personal loans, you could also consider a reverse mortgage, a new line of credit, or a home equity investment.  

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 to 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.

Credit card 

Another financing option for borrowers with low credit scores is to take out a credit card. Although credit cards come with higher interest rates and fees than other financing options, it's a viable solution for those who don’t need to borrow large loan amounts. 

Home equity investment 

Lastly, borrowers should consider applying for a home equity investment (HEI), which 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. Instead, homeowners repay the investment amount plus a percentage of the home’s future appreciation during a 30-year term. Homeowners pay back the HEI in a lump sum when the house is sold, refinanced, or at some other point in time.

A home equity investment is an attractive financing option for homeowners because they come with:

  • Lump sum payouts 
  • No monthly payments
  • If home value goes down, the payback amount may be smaller
  • No restrictions as to how money is used
  • No prepayment penalties ‍
home-equity-loan-poor-credit

Using a Home Equity Investment as alternative financing

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.

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