Worried you wouldn’t qualify for a loan based on your credit score? There are other options too.
In today’s financial landscape, having a less-than-ideal credit score can pose significant challenges when seeking loans or credit opportunities. However, individuals with bad credit who own a home have a potential lifeline to secure financing through a guaranteed home equity loan. These specialized loans allow homeowners to tap into the equity built into their property regardless of their credit history.
A guaranteed home equity loan allows homeowners to leverage the value of their property as collateral, increasing their chances of approval and providing a viable solution for those with tarnished credit profiles. Unlike traditional loans that primarily consider creditworthiness, these loans focus on the homeowner’s equity, enabling them to access funds for various purposes such as home improvements, debt consolidations, or emergencies.
While the guaranteed aspect ensures that lenders have a certain level of protection, it’s crucial to understand the terms, conditions, and potential risks associated with these loans. This article delves into the mechanics of guaranteed home equity loans for bad credit, exploring the eligibility criteria, benefits, drawbacks, and essential considerations for borrowers. By shedding light on this financing option, we aim to empower homeowners with bad credit to make informed decisions and leverage their home equity to improve their financial situations.
What is a Home Equity Loan?
A home equity loan, classified as a second mortgage, allows you to borrow money based on the equity you possess in your home. Equity represents the portion of your home’s value that you truly own, indicating the disparity between your outstanding mortgage balance and the current market value of your home.
The loan amount accessible through a home equity loan is determined by the equity accumulated in your home. Generally, lenders permit borrowers to access up to 80% of their home’s equity. The funds are disbursed as a single lump sum. Requires repayment through fixed monthly installments over a predetermined period, typically five to 30 years. It is important to note that failing to make timely payments and defaulting on the loan could result in the loss of your home due to foreclosure.
Subprime Home Equity Loans
A subprime loan is a type of loan given out to people, especially borrowers with low credit. Many mortgage lenders only accept people that have high credit ratings because of their potential inability to repay the loan. This is also why the interest rate is relatively higher for such loans.
There is a prime interest rate set for prime buyers with a reasonable credit rating; currently, the prime interest rate is 3.25%, but the subprime interest rate is always higher. This is due to the low-credit borrower’s risk of defaulting.
When borrowers enter the mortgage market, they seek lenders to lend them money for their homes. And because of low credit ratings, they often have difficulty looking for lenders. With the subprime loan, borrowers are not in much of a fix.
That said, the lender accepts the risk of the borrower becoming a bad debt, meaning he couldn’t pay. To save the lender from a greater loss, he charges a very high-interest rate from the borrower on the mortgage.
These high-interest rates on subprime loans can translate into thousands of dollars in additional interest payments over the life of a mortgage.
Types of Subprime Loans
As discussed above, subprime loans are granted to high-risk borrowers, and even though the most popular thing about subprime loans is having them for mortgages, they aren’t the only reasons people need them.
Apart from mortgages, subprime loans are granted in the shape of student loans, credit card debts, and car loans. Here are some of the types of subprime loans:
- Interest-only loan: This type of loan allows mortgage borrowers to only pay the interest at the beginning of the loan duration, making it affordable for them to repay during the initial months. But the amount increases soon because the interest is added to the loan. If it is a mortgage loan and the market isn’t performing well, you could be stuck in a huge problem.
- Adjustable-rate loan: With this subprime loan type, the interest rate remains flat for the first couple of years before changing to a floating rate later. So if the loan is for 20 years, you can expect to pay a flat interest rate in the first 2-3 years before it picks up its pace.
- Fixed-Rate Loan: As the name suggests, a fixed-rate loan is one where the interest rate is fixed throughout the duration. But with this, the drawback is that the duration of the loan is relatively higher. A prime loan has a maximum limit of up to 30 years, but with a fixed-rate option, it could easily be 40-50 years.
- Dignity Loan: In a dignity subprime loan, the borrower must put down a down payment equivalent to about 10% of the loan and agree to a higher interest rate for the initial portion. If monthly payments are made on time for this period- usually five years, the interest rate decreases to the prime rate. In addition, the amount already paid on interest will reduce that loan’s balance.
How to avoid defaulting on a Subprime Home Equity Loan?
Even if you’re not a high-risk borrower at your fault, there are chances that you default on the subprime home equity loan because of higher interest rates. Here’s how you can avoid getting to that stage of default:
- Budget your income to include the potential loan payment.
- Check your credit score and fix errors in your credit history.
- Make timely payments each month to improve your credit rating.
- Shop around for alternative lenders.
- Consider asking someone with strong credit and income to cosign on the loan.
- Set a reminder at least 3-4 days before the due date so that you don’t forget to pay, and if you’re short of money, you have time to ask your friends or family.
Minimum Credit Score for Home Equity Loan
To qualify for a home equity loan, a borrower must at least have a credit score of 680. This is just the minimum threshold required; let’s get into the details of credit scores and what is considered good.
The majority of credit scoring systems have a scale with a 300–850 range. However, some credit scoring models—including those utilized by some institutions—exceed 900 or 950.
So the highest score that you can go up to is 850. However, you don’t need to exhaust yourself to reach that 850. Any score in the late 700s to early 800s is great! You are good to go with proceeding with that loan!
This is the average breakdown to be mindful of:
- Excellent: 800 to 850
- Very Good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
FICO utilizes percentages to represent how significant each element is to your credit ratings.
|Length of credit history||15%|
Easy Loan to Get with Bad Credit
FHA loans, as opposed to conventional loans, are very popular in the mortgage market. They are backed by the federal government, which gives lenders some loan guarantees, making it easier for lenders to trust the borrower.
The lender or banks who give out these mortgages are backed by FHA, which is why they have a downpayment as low as 3.5%. This gives lenders an edge even if the borrower defaults on the loan.
Compared to a conventional loan, the interest rates of FHA loans are relatively low because of their backing from the FHA. The interest rate today is 2.81% as compared to the interest rate of conventional loans, which is 2.99%.
Essentially, there are five types of FHA loans:
|FHA LOAN TYPE||WHAT IT IS|
|Traditional Mortgage||A mortgage used to finance a primary residence|
|A reverse mortgage that allows homeowners aged 62+ to exchange home equity for cash|
|A mortgage that includes extra funds to pay for energy-efficient home improvements intended to lower your utility bills|
|A mortgage that includes extra funds to pay for energy-efficient home improvements intended to lower your utility bills|
|Section 245(a) Loan||A Graduated Payment Mortgage (GPM) with lower initial monthly payments that gradually increase (used when income is expected to rise), and a Growing Equity Mortgage (GEM) where scheduled increases in monthly principal payments result in shorter loan terms.
FHA Loan Requirements
Even though it may seem that it is relatively easier for a borrower to obtain an FHA loan, certain requirements set the bar for applicants. Here is what you need to know.
- Credit Score and Downpayment: Like any other loan, an FHA loan heavily depends on the borrower’s credit rating. It should be at least 500-579. That is when you get a downpayment of 10%. But if your score is 580+, you could be eligible for only a 5% down payment rate. It all comes down to this: having a higher credit score will get you a good deal.
- Debt-to-income ratio: A DTI is a measurement metric that simply evaluates how much debt you have against your current income. More DTI will reduce your chances of being qualified. The DTI should not exceed 50%; you’re in the safe zone if it is below 43%.
- Primary residence: One of the requirements for an FHA loan is that the property should be the primary residence of the borrower and meet the minimum criteria of FHA property requirements.
- Proof of employment: The borrower needs to prove that he is employed and has a steady source of income to pay for the mortgage loan. However, this is a relatively easy requirement to fulfill because most people look for mortgages while they already have a steady income from their employment.
Guaranteed Home Equity Loan For Bad Credit
Even for a person with a poor credit rating, there are certain guaranteed home equity loans for bad credit.
|Lender||Best For:||Min. Credit Score||Est. Apr||Min. Loan Amount||Max. Loan Amount|
|Bad Credit Loans||Poor credit scores||Not specified||5.99%–35.99%||Not specified||$10,000|
|Upstart||Limited credit history||600||8.69%–35.99%||$1,000||$50,000|
|OneMain Financial||Secured loans||Not specified||18.00%–35.99%||$1,500||$20,000|
|TD Bank||Low rate caps||Not specified||6.99%-21.9%||$2,000||$50,000|
|Avant||Range of repayment options||580*||9.95%–35.99%||$2,000||$35,000|
|Upgrade||Fast funding||620||7.99%–35.97% (with autopay)||$1,000||$35,000|
Note: Sample rates have been extracted online, courtesy of Bankrate.
How to Remove Equity from Your Home with Poor Credit
If you have bad credit, you may still be able to get equity out of your home through a home equity loan or line of credit. These types of loans are typically available through private lenders, and they use your home’s equity as collateral. If you default, the lender could foreclose on your home.
How to Get a Home Equity Loan Despite Having Bad Credit
Obtaining a home equity loan with a low credit score entails meeting stricter criteria than a traditional mortgage. In the case of failure and lender foreclosure, a home equity loan is regarded as a “second mortgage,” which means it is paid back after the first mortgage.
Suppose you gave bad credit and wish to secure a home equity loan. In that case, the lenders will typically require you to:
- Confirm that you possess at least 15% equity in your home: Home equity lenders usually permit borrowing up to a maximum of 85% of the home’s value. Equity refers to the disparity between the current market value of the home and the outstanding mortgage balance.
- Set a limit on your loan amount based on the combined loan-to-value ratio: The loan-to-value (LTV) ratio gauges the proportion of your total loan amount in relation to the home’s value, expressed as a percentage. The sum of your existing loan balance and the new home equity loan balance must not exceed the LTV ratio limits specified by the lender. While the common limit is 85%, certain lenders might provide options for home equity loans with 100% LTV.
- Assess your credit scores and payment history: Most home equity lenders require a minimum credit score of 620. They will also evaluate the types of accounts you utilize, your outstanding debts, the length of time the accounts have been active, and, significantly, whether you have made timely payments on these accounts.
- Evaluate your debt-to-income ratio: You must demonstrate that your income is sufficient to cover your existing monthly obligations and the new home equity loan payment. Typically, lenders restrict the debt-to-income (DTI) ratio, the percentage of your gross monthly income dedicated to debt repayment, to a maximum of 43%. However, borrowers with poor credit may encounter even more stringent requirements set by lenders.
How to get a HELOC with Bad Credit
Bad credit can make getting a home equity line of credit difficult, but there are ways to improve your chances. One option is to work with a co-signer who has good credit. Another is to look for lenders who specialize in bad credit HELOCs. You may also improve your credit score by paying debts and maintaining a good payment history.
My credit score is 500. Can I still receive a home equity loan?
Getting a home equity loan with a 500 credit score is possible, although not all lenders will approve such a loan. If you want to increase the chances of approval, providing additional documentation or collateral may be necessary. Additionally, lenders may charge higher loan rates to applicants with poorer credit ratings.
Applying for a Home Equity Loan with Bad Credit
The procedure for applying for a home equity loan when you have negative credit is the same as getting a mortgage. There are still some further measures that should be considered.
Review your credit report
It is advised to raise your credit score before applying for a home equity loan with bad credit. Start by examining our credit reports to understand your current standing. If you find any inaccuracies, such as incorrect contact information, contact the respective credit bureau (Equifax, Experian, or TransUnion) to rectify them.
Assess your DTI ratio
Lenders use the Debt-to-Income (DTI) ratio to assess your ability to handle additional debt responsibly.
To calculate your DTI ratio, divide your total monthly debt payments by your gross monthly income. For example, if your monthly income is $6,000 and you have a $2,200 mortgage payment and $110 student loan payment:
$2310/$6,000 x 100 = 38.5%.
To simplify this, you can even use an online calculator.
Most lenders prefer a DTI ratio below 43 percent for a home equity loan. Aim for this target or, at most, keep it below 50%, which is typically considered the maximum acceptable limit.
Ensure sufficient equity for your home equity loan
Before applying for a home equity loan, it’s important to have an appropriate level of equity, typically around 15 percent to 20 percent, to meet lenders’ requirements. Your equity and combined loan-to-value (CLTV) ratio play a significant role in determining your borrowing capacity.
Remember: The loan-to-value ratio (LTV) is calculated by dividing your outstanding mortgage balance by the appraised value of your property. Suppose you have an existing mortgage and are seeking additional financing. In that case, the lender will consider the combined LTV (CLTV) ratio, which includes the total debt on the property – both the first mortgage and the second loan.
To determine your home’s equity, subtract the remaining balance on your mortgage from the current market value of your home. For example, if your home is appraised at $42,000 and you have a remaining mortgage balance of $250,000:
- $420,000 – $250,000 = $170,000.
To calculate your loan-to-value (LTV) ratio, divide your outstanding mortgage balance by the total loan amount and convert it to a percentage.
- $250,000 / $420,000 x 100 = 59.5%.
In this scenario, your equity would be $170,000, and your LTV ratio would be 59.5%.
Suppose you wish to add an $80,000 home equity loan to your existing loans, and your lender requires a minimum of 20% equity. This would result in an LTV ratio (now CLTV ratio) of 78.5%, below the lender’s maximum threshold of 80 percent.
Secure a Co-signer
If your credit is too poor to qualify for a home equity loan independently, enlisting a co-signer could potentially assist you. A co-signer becomes equally responsible for loan repayment, even if they don’t intend to make payments. Remember that if you fail to repay the loan, their credit will be adversely affected, just like yours.
Finding a willing co-signer can be challenging, and it’s essential to remember that you still need to meet individual credit requirements to qualify for the loan. Consider a co-signer as someone who can bolster your loan application and improve your chances of approval rather than relying solely on their good credit.
A cosigner can benefit applicants with lower credit scores, as they can assist with credit and income-related challenges. However, it’s important to note that the main applicant or primary borrower must still meet the minimum credit score requirements set by the bank’s underwriting guidelines. The cosigner’s involvement doesn’t replace the need for the primary borrowers to meet the necessary credit criteria.
Go for lenders you have an existing relationship with
If your bank or mortgage lender provides home equity products, they might be more willing to work with you due to your status as an existing customer, even if your credit is not ideal. For instance, consistent on-time mortgage payment history could be taken into consideration.
A loan officer who is well acquainted with an applicant’s circumstances can assist in effectively presenting their case to an underwriter.
Nevertheless, the final decision lies with the underwriter, which evaluates the loan based on the bank’s guidelines and assesses the perceived risk associated with the individual. Generally, a lower credit score may lead to a higher perception for the lender.
Compose a letter for your lender explaining your credit history
Being upfront about your financial situation may increase your chances of obtaining a home equity loan. One effective approach is to write a letter of explanation to lenders outlining the reasons behind your credit challenges. Attach any relevant documentation, such as bankruptcy records, and present a well-defined plan for repaying the home equity loan.
It is crucial to understand that providing a letter of explanation does not guarantee loan approval. If you face rejection, you can attempt the process with another lender. However, if you experience multiple denials, it may be necessary to dedicate time to rebuilding your credit before reapplying.
What Are Some Alternatives To Home Equity Loans?
When considering financing options for home improvement projects or other expenses, it’s worth exploring alternatives to traditional home equity loans. Here are some options to consider.
Home Equity Line of Credit (HELOC)
A HELOC utilizes your home equity as collateral, like a home equity loan. However, it functions more like a credit card. You can withdraw funds from your HELOC as needed and repay it in full or make monthly payments on a portion of the borrowed amount. By borrowing only what you require, you can save on interest payments. Lenders typically permit borrowing up to 85% of your home’s equity, but this can vary.
HELOs often require a minimum credit score of 700 or higher, as lenders reserve the best interest rates for borrowers with excellent credit scores.
A personal loan provides flexibility for various expenses and is typically uninsured, meaning no collateral is required. Repayment terms vary from a few months to several years. Personal loans carry higher interest rates than home equity loans, so it’s essential to remember this aspect.
A cash-out refinance involves replacing your existing mortgage with a larger one, allowing you to access the equity in your home. After paying off your original loan and deducting closing costs, you receive the remaining difference. Lenders generally permit up to 80% or 85% of your home’s value, but borrowing above 80% LTV may require private mortgage insurance (PMI).
0% APR Credit Cards
Individuals with good credit may qualify for credit cards offering an introductory 0% annual percentage rate (APR) for a specified period, often up to 21 months. You can avoid interest charges by paying off the balance within the promotional interest-free period. However, it’s crucial to note that once the introductory period ends, any remaining balance will accrue interest, often at higher rates.
Exploring these alternative financing options can help you decide based on your needs and circumstances.
Is it possible to obtain a HELOC with bad credit?
While it is possible to secure a HELOC with bad credit, it is important to note that you will likely be charged a higher interest rate.
If I have bad credit, is it better to opt for a home equity loan or a HELOC?
In the case of bad credit, a home equity loan may have a slight advantage over a HELOC. Home equity loans offer fixed interest rates and fixed monthly payments, clarifying the amount to be repaid each month. This predictability can aid in budget management and timely payments.
On the other hand, A HELOC typically comes with a variable interest rate, which means there is a possibility of future payment adjustments. If the payments increase and become unaffordable, it could further impact your credit.
Which option generally carries a higher interest rate: A HelLOC or a home equity loan?
The interest rates for both home equity products have risen significantly since last year and are expected to remain elevated in the foreseeable future. Currently, they are quite comparable.
As of April 2023, the average interest rates for 10– and 15-year home equity loans hover around or slightly above 8 percent, while the average rate of a HELOC is slightly below that. It is advisable to compare the current rates for HELOCs and home equity loans to stay updated on the latest trends.
What is considered a “good” credit score?
According to FICO standards, a credit score between 670 and 739 is considered “good.” VantageScore standards define a “good” credit score as a range between 661 and 780.
Does a higher credit score result in a better interest rate?
Indeed, a higher credit score generally leads to a better interest rate. This principle applies to all types of loans. Including home equity products. The higher your credit score, the lower the interest rate you are likely to receive.
Certain loans like subprime loans are common in the country but often have a very high-interest rate to benefit high-risk borrowers with a low credit rating. Of course, there is a chance of the borrower defaulting on it because of the interest rate, but that’s a risk the lender has to take.
Ensure you know exactly what you’re getting into; check market rates, and talk to several lenders before deciding. Fixing your credit ratings before applying for a subprime loan is advisable, so that you will dodge high-interest rates.
It depends on borrowers’ needs regarding when to opt for a subprime home equity loan.