Getting a home equity loan with bad credit
Home equity loans are a way for homeowners to turn unencumbered equity in their home into cash. And if you have bad credit, a home equity loan is more likely to be approved by a lender – and at a lower interest rate – than a traditional loan or revolving line of credit. The reason is that your house serves as security (collateral) for the loan, which reduces the financial risk in the eyes of a lender.
Lenders typically provide loans of up to 80% of the equity in your home. The more equity you have, the more attractive you will be, especially if you own 20% or more of the free and clear house. This can be particularly useful when you have a bad credit score. Here, we take a closer look at the possibility of getting a home equity loan if your credit is relatively bad.
Key points to remember
- Home equity loans allow homeowners to borrow against the debt-free value of their home.
- If you have bad credit, you may still be able to get a home equity loan since the loan is secured by the house itself as collateral.
- A major downside, then, is that you are going to put your house at risk if you cannot repay it because you are taking on more debt with the loan.
Disadvantages of Home Equity Loans
While a home equity loan can be useful if you have bad credit, there are some serious downsides to understand. You can expect less favorable terms on your home equity financing, for example, than if your credit were better. You may be limited to a lower loan amount and need to provide more collateral (ie more equity). You may also have to pay a higher interest rate during the life of the loan.
A home equity loan also adds to your total mortgage debt on the property, which could put you in a vulnerable position if you lose your job or face unforeseen bills and struggle to pay. all your payments on time. Additionally, you may be hit with large late payment charges that your lender will report to the credit bureaus, which will worsen your credit.
The biggest downside is that the lender could ultimately grab on your property if you are unable to pay the debt, leaving you homeless.
With these important drawbacks in mind, there are a number of alternatives that you can consider rather than using the equity in your home as collateral for a loan. Even if you have less than stellar credit, you may be able to access a number of emergency loan options to help you overcome a financial emergency without risking your home.
Home Equity Loans Versus HELOCs
There are two main options for home equity financing. With a home equity loan, you borrow a sum of money and pay it back in regular installments, usually at a fixed interest rate, over anywhere from 10 to 30 years.
The second type is a home equity line of credit (HELOC), in which the lender sets aside an amount of money that you can borrow on a turning based. Most HELOCs charge adjustable interest interest rates, offer only interest payments, and have a five to 10 year “drawdown” period, during which you can access the funds.After the drawdown period is over, you have to pay off the outstanding balance over a specific period, typically 10 to 20 years, but sometimes this is a lump sum payment that requires payment in full.
Steps to follow before applying
Here’s what you need to know and do before applying for any type of home equity financing.
Read your credit report
Get a copy of your credit report, so you know exactly what you are up against. You are entitled to one free each year from each of the three major national credit bureaus (Equifax, Experian and TransUnion) through the official website authorized by federal law.Check the report carefully to make sure there aren’t any mistakes that hurt your score (it’s a good idea to do this every year anyway).
Prepare your finances
Gather your financial information, such as proof of income and investments, so it’s ready to be presented to lending institutions. They will want to see in black and white that you are financially stable enough to support your loan, especially if you have bad credit. If possible, pay off any outstanding debt that could negatively impact your claim.
If the loan can wait, you may want to use the time to improve your credit score.
Consider how much money you need
Ask yourself: what is the purpose of this loan? And how much money do I need for this? It can be tempting to aim for the stars and maximize your loan amount, perhaps to provide a financial cushion just in case. Yet that is only if you are sure you can resist the temptation to spend it all. If your spending habits are under control, it may be a good idea to ‘borrow’, and by using a HELOC you only pay interest on the money you actually take out.
However, in the case of a home equity loan, you will be paying full interest (and principal) on the entire lump sum, so it makes sense not to borrow more than you need.
Compare interest rates
It makes sense to go directly to your current lender for home equity financing. Since you are already a customer, this lender may offer a more attractive rate. However, there is no such thing as a secured home equity loan if you have bad credit, so it is wise to shop around. By obtaining multiple quotes, you will be in a better position to negotiate the best possible rate. Take your first offer to another lending institution and see if they beat it.
An independent mortgage broker can also be helpful as they work for you and not for the lender.
Don’t forget the other costs
When you compare loan offers, don’t just focus on the interest rate. Make sure you educate yourself about any other associated fees, such as loan processing and closing costs. This way you can compare the loans on a fair basis and you will not be surprised afterwards.
Recruit a co-signer
To put yourself in a better position to borrow, it may be a good idea to hire a co-signer, someone who uses their credit history and income to act as a guarantor for the loan. Make sure you choose a co-signer with impressive credit, good job stability, and significant income to maximize your chances of getting approved. This person, of course, must be aware of the co-signer risks a loan if you can’t pay it back.
Possibly look at subprime loans
As a last resort, you can turn to lenders offering subprime loans, which are easier to qualify and target low-credit borrowers who do not meet traditional lending requirements.
Subprime lenders generally offer lower loan limits and significantly higher interest rates. However, you should avoid these loans whenever possible, especially if you already have credit problems.
The bottom line
If you find that a bad credit history is hurting you, ask your lender what they need from you (and your credit history) to improve your prospects. It’s never too late to reverse your credit score. If possible, consider putting your borrowing plans on hold while you take steps to improve your rating.
Mortgage lenders typically look at factors such as your payment history, the level of existing debt, and the length of your credit accounts. Do you frequently miss payments, generate large balances or request new accounts? Simply changing any of these behaviors can have a positive impact on your credit score and make future borrowing easier.