Published April 28, 2023
Written by Dori Zinn
Edited by Troy Segal
It can be challenging to get approved for a home equity loan with bad credit, but there are ways to make it happen.
The tradeoff: You’ll likely have to pay a higher interest rate, or have more income or more equity in your home to compensate for the additional risk.
Focus your search: There are some major home equity lenders out there that can and do work with borrowers with bad credit.
Some alternatives to home equity loans could include personal loans or cash-out refinances.
Having poor credit means you might face a tougher time borrowing money. But it’s not an impossible dream.
There are some major home equity lenders out there that can and do work with borrowers with bad credit. The tradeoff: You’ll likely have to pay a higher interest rate, or have more income or more equity in your home to compensate for the additional risk. However, the higher rate might be worth it if you plan to use the home equity loan to renovate your residence — enhancing its value and improving your financial wellbeing.
How to qualify for a home equity loan with bad credit
Not all home equity lenders have the same borrowing criteria, but the general requirements include:
A minimum credit score of 620
At least 15 percent to 20 percent equity in your home
A maximum DTI ratio of 43 percent, or up to 50 percent in some cases
On-time bill payment history
Stable employment and income
Lenders that offer home equity loans with bad credit
Yes, there are unscrupulous lenders out there who prey on people with poor credit. But there are plenty of reputable players too.
Home equity lender Loan type Credit score minimum
Discover Home equity loans (under $150,000) 620
Figure HELOCs (primary residence) 640
Guaranteed Rate HELOCs 620
Spring EQ Home equity loans (under 95 percent combined loan-to-value ratio) 620
TD Bank HELOCs and home equity loans 660
How to apply for a bad credit home equity loan
1. Check your credit report
While it’s possible to get a home equity loan with bad credit, it’s still wise to do all you can to improve your score before you apply (more on that below). To start off, check your credit reports to get a sense of where you stand. If there are any errors, like incorrect contact information, contact the credit bureau — the three biggies are Equifax, Experian and TransUnion — to get it updated.
2. Evaluate your DTI ratio
The DTI ratio is a measure lenders use to determine whether you can reasonably afford to take on more debt.
To find out your DTI ratio, simply divide your monthly debt payments by your gross monthly income. For example, say you bring in $6,000 a month in income and have a $2,200 monthly mortgage payment and a $110 monthly student loan payment:
$2,310 / $6,000 x 100 = 38.5 percent
To make things even easier, you can use Bankrate’s DTI calculator.
For a home equity loan, most lenders look for a DTI ratio of no more than 43 percent. So try to aim for that — or at the very most, stay below 50 percent, the drop-dead cutoff.
3. Make sure you have enough equity
To qualify for a home equity loan, lenders typically require you to have at least 15 percent or 20 percent equity. Your equity level and combined loan-to-value (CLTV) ratio help determine how much you can actually borrow.
Keep in mind: Your loan-to-value ratio (LTV) is your mortgage’s outstanding balance principal, divided by how much your property is worth. If you already have a mortgage and want to apply for more home-backed financing, your lender will evaluate the combined LTV (CLTV) ratio, which factors in all of the debt on the property — the amount of the first mortgage, plus that of the second loan.
To calculate your home’s equity, take the current market value of your home and subtract the balance left on your mortgage. For example, let’s say that your home was appraised for $420,000 and you still had $250,000 on your mortgage to pay off.
$420,000 – $250,000 = $170,000
To calculate your loan-to-value (LTV) ratio, you’ll divide your outstanding mortgage balance by your total loan amount and convert it into a percentage.
$250,000 / $420,000 x 100 = 59.5 percent
In this case, you’d have $170,000 in equity and an LTV of 59.5 percent.
Now, say you want to add an $80,000 home equity loan to the mix, and your lender requires you to maintain at least 20 percent equity. That’d bring your LTV ratio (now your CLTV ratio) to 78.5 percent — below the 80 percent threshold your lender has limited you to.
You can use Bankrate’s LTV calculator and home equity loan calculator to estimate your CLTV ratio and what you might qualify for.
4. Get 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 might be able to help. On paper, the co-signer is just as responsible for paying the loan back as you are, even if they don’t actually intend to make payments. If you fall behind on repaying the loan, their credit suffers along with yours.
It can be tough to find someone who’s willing to commit to a loan, however, and you’ll still need to qualify for it based on your individual credit. Think of a co-signer as someone who can help strengthen your loan application and increase your chances of approval, rather than someone whose good credit means yours gets overlooked.
“A co-signer can help with credit and income issues for an applicant who has a lower credit score, but ultimately the main applicant or primary borrower will have to have at least the bare minimum credit score that is required based on the bank’s underwriting guidelines,” says Ralph DiBugnara, president of Home Qualified.
5. Try a lender you already have a relationship with
If your bank or mortgage lender offers home equity products, it might be more willing to work with you since you’re an existing customer, even if your credit isn’t up to par. For example, if you have a consistent history of making your mortgage payments on time, your lender might take that into consideration.
“A loan officer familiar with the details of an applicant’s situation can help them present it to an underwriter in the best possible way,” says DiBugnara. Still, “the underwriter will decide based on the bank’s guideline and the perceived risk level of the loan. The lower the credit score, the more risk the person will be perceived to be.”
6. Write a letter to the lender explaining your credit history
You may find more success in getting a home equity loan if you’re upfront about your financial situation. One way to do this is by writing a letter of explanation to lenders, describing why your credit has taken a hit. You’ll also want to attach any relevant paperwork (like bankruptcy documentation) and outline a plan for how you’ll repay this home equity loan.
It’s important to note, however, that simply providing a letter of explanation isn’t a guarantee that you’ll get approved for a loan. If you get rejected, you can repeat the process with another lender, but if you’re denied multiple times, you may need to spend some time building your credit before applying again.
Ways to improve your credit
To increase your chances of getting approved for a home equity loan, work on improving your credit well in advance of applying. Here are three tips:
Pay bills on time every month. At the very least, make the minimum payment, but try to pay the balance off completely, if possible.
Don’t close credit cards after you pay them off — either leave them open or charge just enough to have a small, recurring payment every month. That’s because closing a card reduces your credit utilization ratio, which can decrease your score. The recommended utilization ratio: no more than 30 percent.
Be cautious with new credit. Getting a higher credit limit on a card or getting a new card can lower your credit utilization ratio. But not if you immediately max them out or blow through the bigger balance. Treat the newly available funds as sacred savings.
Home equity loan alternatives if you have bad credit
There are four main alternatives to a home equity loan:
Home equity lines of credit (HELOCs)
Home equity lines of credit (HELOCs) apply the same concept as home equity loans: You can borrow a certain amount of funds based on the equity you have in your home. HELOCs are a revolving line rather than a fixed-sum loan, which gives you much more flexibility. They can be a good option for ongoing expenses, such as a long-term remodeling project. They have variable interest rates, however, which means your rate can go up or down. This makes them tougher to budget for.
Personal loans can be somewhat easier to qualify for than a home equity product, and they aren’t tied to your home. This means that if you fail to repay the loan, the lender can’t go after your house. Personal loans have higher interest rates, however, and shorter repayment terms. With bad credit, this translates to a much more expensive monthly payment compared to what you might get with a home equity loan.
In a cash-out refinance, you take out a brand-new mortgage for more than what you owe on your existing mortgage, pay off the existing loan and take the difference in cash. Most lenders require you to maintain at least 20 percent equity in your home in order to cash out. A caveat, however: A cash-out refi only makes sense to do if you can qualify for a lower rate than what you have on your current mortgage, and if you can afford the closing costs. With bad credit, getting that lower rate might not be possible.
Reverse mortgages allow homeowners over the age of 62 to tap into their home’s equity as a source of tax-free income. These types of loans need to be repaid upon your death or when you move out or sell the home. Reverse mortgages can be used for anything from medical expenses to home renovations, but you must meet some requirements to qualify. Most importantly, you’ll need to own your home outright or have paid off most of your mortgage. It might make sense to consider a reverse mortgage over a home equity loan if you want an ongoing source of cash and don’t care about passing your home down to your loved ones after you die.