Get a Home Equity Loan With Bad Credit

A home equity loan is a line of credit which uses your home as collateral. While you can't magically improve your credit score, there are a few things you can do to improve your credit within a few months. You can still get a home equity loan even if you have bad credit, but slight improvements to your score will help you get approved and earn you a better interest rate.

Steps

Understanding Loan Types

1. Know the two types. A Home Equity Loan (HEL) and a Home Equity Line of Credit (HELOC) are slightly different. Knowing the differences between these types of equity will help you decide which is best for you, and may help you negotiate a better rate. Both types of equity allow you to borrow up to 85 percent of the value of your home, depending on the bank.
   • A Home Equity Loan (HEL) is a loan for a lump sum of money using your house as collateral. You repay the loan and associated interest in monthly payments over a fixed term. It is very similar to a mortgage in these ways.
   • A Home Equity Line of Credit (HELOC) is slightly different because it is a line of credit instead of a lump sum loan. With a HELOC, you are allowed to borrow as much money as you need. You only make payments based on the amount you borrow. The HELOC also uses your home as collateral.
2. Learn the advantages of each. There are distinct advantages and disadvantages to the HEL and the HELOC, and understanding them will help you decide which type of equity is right for you.
   • The HEL is fixed. That includes a fixed interest rate, fixed loan amount, and fixed repayment schedule.
   • Payments on a HEL are higher than with a HELOC. This is because your monthly payments for a HEL include the principal cost.
   • A HELOC is more flexible the the HEL because you can borrow money as it is needed. This also leads to less stable monthly payments with the HELOC.
   • The interest rate for HELOCs is tied to an index and as a result, the interest rate changes each month. This variable interest rate can make it harder to budget.
3. Decide what suits you best. Because there are distinct differences in both types of loan, one or the other is better based on your personality and specific finances. You may need to explore offers in order to make your decision. Discuss your specific situation with potential lenders to help decide which option is best for you.
   • If you like the idea of consistent monthly payments, a HEL may be the better option.
   • If you’re not sure how much money you will need, a HELOC may be better. In a similar vein, if you know exactly how much money you’ll need, a HEL may be the better option.

Improving your Credit

1. Obtain a copy of your credit reports. While obtaining a home equity loan with poor credit is possible, taking some time to improve your credit can go a long way in not only increasing your odds of approval, but also getting a better rate. Checking your credit report allows you to see how bad your credit is. Generally, it is very difficult to get a home equity loan if your credit is lower than 620.
   • To get your free credit report, visit annualcreditreport.com. This site allows you to get one free credit report every 12 months from each of the three credit bureaus -- Equifax, Experian, and TransUnion. It is recommended you get one report from each bureau, since they all present information in different ways.
   • Your credit report will include a record of all your credit inquiries and credit accounts.
   • You will sometimes be asked to pay a small additional fee to see your credit score, but free sites do exist. After you get it, it is important to Understand-Your-FICO-Credit-Score.
   • If you cannot afford the small fee, search Google for "credit score estimator tool" and there are many online tools to estimate your credit score using information from your credit report.
   • myBankrate.com also offers free credit reports and scores.
2. Review credit reports for inaccuracies. Inaccurate or missing information in your credit report can reduce your credit score, and mistakes are more common than you would imagine. Periodically review your credit report and report any errors to the credit reporting company. Be sure to look over your credit report before applying for a home equity loan to increase your chance of approval and get the best possible rates.
   • Check for credit you did not apply for, other peoples debts that are reported on yours inaccurately, or bad debts from your spouse.
   • Check for old credit inquiries. When you apply for credit and your credit report is checked, it harms your credit score. However, these inquiries should not be on your report for more than two years.
   • If you filed for bankruptcy, this should no longer be on your report after ten years.
3. Reduce your credit card balances. The lower your credit card balance is, the better your credit score will be. Pay off credit card debt as quickly as possible and your credit score will improve as a result. In addition, your odds of getting improved for a home equity improve the lower your debt is -- lenders take into account how much debt you have relative to income.
   • Don't cancel your cards, having less available credit will hurt your score even further.
   • If necessary, stop using your credit cards until you can pay off debt.
4. Negotiate with your lenders. If you stopped paying a particular debt, or had a debt sent to collections you can always ask your lender to erase that debt or any account that went to collections in exchange for paying the remaining balance.
   • If you were a good customer prior to the period of poor payment, and you can link the poor payment to a specific reason (like becoming unemployed), the lender may agree to have the bad debt removed from your credit report in exchange for paying the balance (or some of the balance).
   • Contact your lender to discuss this option.
5. Ask for a credit limit increase. One of the ways your credit score is determined is by looking at how much of your available credit you have used. The lower the number, the better. Therefore, by increasing your credit limit (at the same time as you focus on reducing your balances), you can have less of your available credit used.
   • The very important point here is that you do not use the additional credit. If you do, you may end up worsening your credit score.
6. Pay your bills on time. This includes more than just credit cards and loans. Pay your utility bills and other similar bills on time too: they can all affect your credit score. Many utility providers offer an auto-payment option which will help you pay your bills on time. Alternatively, use an electronic calendar or reminder system, or make notes on your planner.
   • A record of good payment history makes up 35% of your credit score.
7. Leave good debt on your credit score. "Good debt" is any debt for which you made all payments on time. Some people have the idea that once a loan is settled, it is beneficial to remove it from your credit score. This is not the case for good debt, which can actually benefit your credit score.

Increasing Your Odds of Approval

1. Explain the reason for your poor credit to your lender. If you do have poor credit and have taken steps to improve it, be open about it. Explain to your lender any circumstances that lead to your poor credit (unemployment, medical expenses, a personal emergency) and they will likely take this into account when choosing to accept your loan.
2. Consider a co-signer. A co-signer is someone who guarantees to pay back a loan if you cannot. Home equity lenders typically look at your income and your credit score, and if either are not sufficient, having a co-signer with better income or credit sign for you can help get you approved for the loan.
   • If you have a parent, sibling, or close friend who is willing to help shoulder the loan with you, consider approaching them. Just make sure that they are aware that the full burden of the loan is their responsibility should you become unable to pay it.
   • Make sure you are very confident in your ability to make payments before involving a co-signer. Your co-signers credit will be equally damaged in the event you cannot repay.
3. Consider options to increase your income. One of the factors that lenders look at is the debt-to-income ratio. Meaning if your income is high relative to how much you owe, you have a better chance of getting approved. Generally, lenders like your debt-to-income ratio to be lower than 40% (your debt is only 40% of your income). This is why exploring options to increase your income can help gain approval.
   • Is there an option to work more hours, get a second job, do contracting/freelance work, or ask for a raise?
4. Shop around for multiple lenders. Look beyond your current bank and lender for a home equity loan. Every lender has different requirements for offering home equity loans, and the best way to get approved is to contact as many lenders as possible. Doing this helps you not only identify the lenders who are willing to work with you, but also identify the best rates.
   • Remember to look not only at banks, but to consider credit unions as well. They can often offer better rates on home equity loans.

Finding the Best Deal

1. Negotiate the interest rate. The interest rate is the single most important detail when negotiating a loan. With good credit, banks will more openly compete for a loan. With bad credit, you need to take initiative and negotiate the terms of the agreement by yourself.
   • Explain any medical bill debt. Many times, lenders are more willing to work with you if your credit score is negatively affected by medical bills. Some lenders even remove medical debt from the equation when calculating your interest rate.
   • Compare multiple quotes. Get a quote from your bank or credit union, and consider getting quotes from other banks and credit unions nearby. There are also many online services that will give you quotes for a home equity loan or line of credit.
   • Don’t be afraid to turn a lender down. If you don’t like your offer, or you think you can do better, don’t accept it. Patience will help you get a better offer.
   • Make banks compete against each other. Tell your potential lenders that you are shopping around for better rates, as this will provide with some leverage in your negotiation. See which lenders are willing to negotiate the terms of your loan, and which aren't.
2. Negotiate the details. There are many lenders who will happily take advantage of someone with bad credit and a lack of knowledge. By understanding the terms of the loan, you can properly negotiate your contract and avoid being taken advantage of. Some common details worth negotiating are detailed below.
   • Interest rate. This is the most important detail to negotiate, and will end up saving you the most money if you are able to get a good offer.
   • Closing costs. The lender is legally obligated to provide you with a Good Faith Estimate of the closing costs. Compare closing costs between your offers and take note of any which seem particularly high. Make sure you plan for closing costs when you are measuring your finances for payments. Making your monthly payments is important, but missing the closing costs can undo all of your diligent work.
   • Rate structure. Some home equity loans have the option to be adjustable or fixed. While fixed rate loans have lower risk to the borrower (because the rate is fixed and will not change), adjustable rate loans can be beneficial for people who plan to sell their homes within the next several years. Adjustable rate loans change their rate over time - if you’re considering one be sure to look at the periodic cap (the limit for rate changes at any one time). Also check the lifetime cap (the limit for rate changes throughout the loan term).
3. Re-read your terms before accepting. Read over the terms of your loan carefully before signing the final documents. Make sure no unrequested changes have been made in the contract. Ask questions about any details which are unclear. This is a good way to catch and avoid deceptive lender practices.
   • If you feel like you are being scammed or taken advantage of, consider using another lender.

Recognizing the Risks

1. Be careful for deceptive lenders. There are a few common bad practices to keep your eye out for, and lenders are more likely to try these practices on someone with bad credit. A few examples are outlined below.
   • Loan Flipping involves repeated encouragement to refinance your loan, and borrow more money each time. Refinancing comes with fees and increases your interest rate.
   • Insurance Packing is the policy of adding unnecessary insurance, such as credit insurance, to your loan.
   • Bait and Switch is a tactic used by lenders to offer a set of terms, and then push higher charges right before you sign the paperwork. If your lender tries to change the loan terms on you last minute, don’t fall for it.
   • Equity Stripping is when a lender offers you a loan that is solely based on the value of your home and not on your ability to repay. This is an attempt to have you default on your loan and forfeit your property. To avoid this, look at your finances and be sure you can confidently pay each monthly payment.
2. Recognize the consequences of defaulting. Because your house is being held as the source of collateral, defaulting on a home equity loan can put your home in danger. Before you decide to open either of these types of loans, be sure you can pay the borrowed money back.
   • Don’t borrow more than you can repay. This is the easiest way to lose your house to a lender.
3. Check for prepayment penalties. Some home equity loans will punish you for paying ahead of schedule. This means that, even if you are able to pay off your debt earlier than expected, you may not be able to. If there is a distinct possibility of paying your debt ahead of schedule, consider negotiating the prepayment penalties out of the contract.
4. Know the Three-Day Cancellation Rule. If for some reason you realize you have made a mistake, and less than three days have passed since the contract was signed, you can legally cancel the contract. You have until midnight on the third business day to cancel the transaction, starting on the day you sign the credit contract. You can only cancel if you are using your principal home as collateral.
   • If you decide to cancel, you must tell the lender in writing.

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Sources and Citations

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