Home equity loans and HELOCs typically do not have the stringent credit requirements that other consumer loans and credit cards do. Since they use your home as collateral, the loan is seen as far less risky to the lender. However, this doesn’t mean that your FICO score is totally irrelevant.
How Hard Is It to Get a Home Equity Loan With Bad Credit?
A significant amount of equity is attractive because it essentially makes up for any debt you might have, or lack of credit history. If you have 20% or more equity in your home, in most cases you will be seen as a lower risk candidate, and this will make up for your poor credit situation.
While your choice will be more limited, there are plenty of lenders willing to extend home equity loans to those with bad credit for the reasons above. The list of institutions will still be longer than it would should you be trying for a personal loan or credit card. So getting approved for the home equity loan with bad credit isn’t so much the “hard” part as the terms you will have to accept.
What Will Be the Penalties for Bad Credit?
Right of the bat, you aren’t going to get the kind of interest rate someone with average or good credit is going to get. But, even though your rate may be high for a home equity loan or HELOC, it is still very likely lower than traditional revolving credit lines and loans. This is one of the reasons home equity loans are considerably popular.
Also, you might have to accept a lower amount than is usually paid out to those with good credit in order to minimize the risk to the bank. For home equity loans and HELOCs, lenders on average will allow you to borrow up to 80% of your equity minus taxes and fees. Bad credit might force you to accept less than this. The good news is, although you can use these funds for anything you choose, you might be able to use them to actually improve your credit.
How Can a Home Equity Loan Improve My Financial Situation?
The cash from a home equity loan can enable those with bad credit to do things they would not be able to if they had no equity in their house. For example, making the right home improvements could significantly increase their home’s market value. In this scenario you’d be removing the equity in your home in order to ultimately create more equity. This might improve your financial future but not do much in terms of your credit score.
In certain scenarios the home equity loan could actually positively impact your credit report and FICO score. Credit bureaus like to see a healthy mix of types of credit on your report. Adding an installment loan is actually a good thing if you’ve got a lot of revolving credit (credit cards). What’s more, making timely payments on this loan, and not missing any payments, can positively affect the “payment history” component of your report. At 35% this is the single most important factor determining your credit score.
Using the home equity loan to pay off credit cards and consolidate debt – and this isn’t recommended for every situation – can also improve your FICO score. After payment history the next biggest factor influencing your score is “credit utilization.” Carrying high balances on credit cards will negatively affect your credit. Using the funds from a home equity loan payout to bring your utilization ratios down to 0%-30%, which is the ideal percentage.
Private Mortgage Insurance
In a traditional first mortgage, private mortgage insurance is required if the borrowers down payment is less than 20%. This protects the lender should the homeowner default on the loan. It costs anywhere from .25% to 2% of the yearly loan balance and the deductible is paid by the borrower. PMI can allow those who don’t have a sufficient down payment to still buy the house they desire.
When it comes to home equity loans, PMI can be a negotiating tool for those with bad credit. While most borrowers are typically looking to avoid paying private mortgage insurance, those whose score is less than stellar can opt to pay it in order to get access to the loan sums available to good credit borrowers.
When it comes to applying for home equity loans with bad credit, having the most possible options is the key. That’s why going with our affiliate LendingTree is a good idea. You’ll be able to immediately get a ballpark idea of the kind of rates you can expect from various lenders in your area.