A home equity line of credit (HELOC) offers a flexible way to leverage the equity you’ve built up. Like a credit card, you can access cash as needed. Plus, you control borrowing costs as interest is only assessed on the funds you withdraw. But there’s a major downside.
Accessing a HELOC can be complicated if you have poor credit. Still, you could be in luck, as certain lenders may be willing to work with you despite a low credit score if there are other compensating factors.
This guide explores how HELOCs work, why they’re difficult to secure if you have poor credit and how to increase your chances of approval. It also includes alternatives to HELOCs if you need funding but would prefer to explore other options.
Understanding What a HELOC Is
A home equity line of credit (HELOC) is a financial tool that could meet your borrowing needs if you’ve built up a significant amount of equity in your home. Before diving too deep, understand that equity is the portion of your home’s value that you own outright. Essentially, it’s the difference between your property’s current market value and the remaining balance on your mortgage.
Unlike a traditional loan, a HELOC is a form of revolving credit that operates like a credit card, providing you with a line of credit that you can draw from as needed. With a HELOC, you have the flexibility to withdraw any amount up to the credit limit at any given time during the “draw period,” which typically lasts for up to 10 years.
The interest rates on HELOCs are usually variable, meaning they can fluctuate over time based on underlying market trends. This also means your payments will change over time.
HELOCs also act as second mortgages. They are secured against your property, which means a default could result in foreclosure. So, it’s vital to borrow responsibly to avoid the potential drawbacks that result if the loan isn’t adequately managed.
Factors Affecting HELOC Approval
When you apply for a Home Equity Line of Credit (HELOC), lenders closely examine your creditworthiness. Your credit score and history play significant roles in determining whether you’ll be approved and the terms you’ll receive.
What Is the Lowest Credit Score for a HELOC?
Generally, the minimum FICO score needed for a HELOC is around 620. However, some lenders may allow lower scores with additional requirements or other compensating factors. Still, a low credit score could limit your options and result in less favorable loan terms, including steep interest rates.
The Impact of Having Poor Credit
Having poor credit can significantly affect your chances of getting approved for a HELOC. As previously mentioned, lenders perceive you as a higher risk, which could lead to a higher interest rate, a lower credit line, or a potentially longer approval process.
Your credit history also affects the lender’s decision. Late payments, high debt-to-income ratios and recent bankruptcies can deter lenders. Even if you qualify, the impacts can result in more stringent borrowing guidelines to secure approval.
The Challenges of Getting a HELOC with Poor Credit
HELOCs afford homeowners with equity a ton of flexibility, but they come with their fair share of challenges if you have bad credit. These include:
- Higher Interest Rates: Lenders typically reserve the most competitive rates for borrowers with solid credit. If you have a low credit score, you’ll likely be offered higher interest rates, which could tremendously increase borrowing costs.
- Stricter Lending Requirements: With poor credit, meeting the lender’s criteria becomes tougher. A lender may require a lower maximum loan-to-value ratio or proof of steady income, making it more complicated to qualify for the loan.
- Limited Access to Lenders: Not all financial institutions offer HELOCs to individuals with bad credit. Those that do might offer less favorable terms, which means you’ll have to spend more time looking for a lender willing to do business with you.
- Potential for Additional Fees: You might encounter additional costs, such as higher origination fees or closing costs, as lenders try to offset their risk when dealing with bad credit.
How to Get a HELOC with Poor Credit
It’s not impossible to get a HELOC with a lower credit score. Below are some tips to help prepare your financial profile and boost your chances of success when applying.
Know How Much You’re Going to Need
Start by calculating the specific amount you need from a HELOC. Estimating too high can increase your borrowing costs while understanding your needs might not cover the expenses you’re looking to cover. Either way, take your time during this step to ensure you apply for the right amount.
Assess Your Credit Report
Review your credit reports in their entirety from the three major credit bureaus – Experian, TransUnion and Equifax. Highlight any inaccuracies that might affect your credit scores negatively. File disputes promptly with the appropriate credit bureau(s). Correcting these issues is essential before applying, as they could be dragging down your credit score.
Calculate How Much Equity You Have
Determine the equity available in your home by subtracting any outstanding mortgage balance from the appraised value of your property. You’ll need substantial equity to qualify for a HELOC, ideally more than 20 percent. However, some lenders will approve you with as little as 15 percent, but you’ll have to do a little legwork to find these options.
Check Your DTI Ratio
Your debt-to-income (DTI) ratio should not exceed 40 percent if you want the best chance of getting approved. This represents the portion of your monthly income that goes towards paying debts, including the potential HELOC monthly payments.
Get Your Financials and Documents Ready
Prepare your financial documents in advance. This includes proof of income, employment, tax returns and investment statements. Your financial health must be transparent to reassure lenders you’re a good fit for a HELOC despite your poor credit rating.
Find a Co-signer
Ask a friend or relative with better credit to apply as a co-signer with you. Their credit strength could offset your poor credit. Keep in mind that they’ll share responsibility for the loan. So, if you default, the debt payments become their responsibility.
Other Steps You Can Take to Improve Your Chances for Approval
If the steps mentioned above aren’t enough to convince a lender you’re a good fit for a HELOC, here are some additional strategies to try.
Avoid Transactions That Lower Your Score
In the months leading up to your HELOC application, be mindful of any activity that could decrease your credit score. This includes avoiding late payments and not opening new lines of credit, which can indicate elevated risk to potential lenders.
Try to Lower Your DTI
Work on reducing your DTI by paying down debts, which can improve your eligibility for a HELOC. Aim for a DTI of 36 percent or lower, even if the lender is willing to accept a higher figure.
Consider Writing a Letter to the Lender Explaining Your Poor Credit
A well-crafted explanatory letter can provide context for your credit history. Discuss any extenuating circumstances that contributed to your poor credit and highlight steps you’ve taken to remedy the situation.
Find a Lender Who Offers HELOCs with Poor Credit
Some lenders specialize in HELOCs for customers with bad credit. Conduct thorough research to find these institutions, as they may have programs tailored to your specific situation.
Alternatives to HELOCs for Borrowers with Poor Credit
You may want to look beyond HELOC to access cash if you have a lower credit score. In this case, here are some viable alternatives to consider.
Considering Personal Loans
Personal loans offer a flexible solution for those who might not qualify for a HELOC due to poor credit. They provide a lump sum of money upfront, which can be used for a variety of purposes, from consolidating debt to making home improvements. A key advantage of personal loans is their fixed interest rates. This means your monthly payments stay the same over the life of the loan, making it easier to budget for them.
For borrowers with less-than-stellar credit, it’s important to understand that while personal loans are available, the terms will likely differ from those offered to borrowers with good credit. Higher interest rates are common, reflecting the increased risk the lender takes on. However, some lenders specialize in bad credit personal loans and offer more competitive rates for those with poor credit histories. This is especially common among online lenders, who are known to feature more flexible eligibility guidelines.
Shop around with several lenders, and be sure to compare offers. Look not only at the interest rates but also at fees, loan terms and the lender’s reputation. Some lenders may offer prequalification tools that let you view potential rates without impacting your credit score, which can be a helpful way to gauge what you might qualify for.
Home Equity Loans as an Option
A home equity loan might still be within reach even with poor credit. Unlike HELOCs, these are lump-sum loans that have fixed interest rates. Keep in mind that borrowing against your home’s equity does put your property at risk if you’re unable to make payments.
Still, they can be a viable alternative for those who need a specific amount of money for a one-time expense, such as a significant home renovation, medical bills, or to consolidate high-interest debt. The fixed interest rates mean that you can lock in the current rates, which can be beneficial in an environment where rates are expected to rise. Plus, you’ll get a predictable monthly payment.
For those with poor credit, lenders may still extend home equity loans, but they often come with higher borrowing costs to compensate for the increased risk. Furthermore, lenders might require a lower loan-to-value (LTV) ratio, which means you may need to have a larger amount of equity built up in your home to qualify. Lenders could also require additional
documentation or ask that you meet other benchmarks to ensure that you have the means to repay the loan.
It’s also worth exploring different types of home equity loans. Some financial institutions offer products specifically designed for individuals with less-than-perfect credit. These products might come with different terms, such as shorter repayment periods or higher fees, but they can provide the necessary funds when needed.
Before applying, consider the full financial picture, including the terms of the loan, any applicable fees and how it could impact your credit health. Reaching out to a financial advisor can provide valuable insight into whether a home equity loan is the right choice for your financial situation.
FHA Title Loans
For a less conventional option, FHA Title I loans help homeowners finance home repairs and improvements, even if they don’t have much equity. These loans are secured by your property but rely on FHA insurance to protect the lender, easing the requirements for those with bad credit.
Another key benefit of FHA Title I loans is that for loans under $7,500, the loan may not even need to be secured by your home. This means it could be considered unsecured debt. However, for larger amounts, the loan would typically be secured by a mortgage or deed of trust on the property.
The terms of FHA Title I loans can also be attractive. They generally offer fixed interest rates and longer repayment periods, which can make monthly payments more manageable for borrowers. The maximum loan amounts can be substantial enough to cover many types of repairs or renovations that can increase the value of your home or improve its functionality.
It’s important to note that FHA Title I loans are not provided by the FHA directly but are issued by private lenders that are approved by the FHA. Borrowers must find a lender who participates in the program and then go through their application process. While the FHA insurance helps with qualifying, lenders will still have their own requirements, including a minimum credit score or income verification.
Cash-out Refinancing
Cash-out refinancing affords you the opportunity to refinance your mortgage and borrow more than what you owe, using the difference in cash. This option might offer lower interest rates compared to personal loans and can be suitable if you’ve built a significant amount of equity in your home. Remember, this will replace your existing mortgage, potentially with new terms.
Furthermore, this mortgage product can offer several advantages. For one, because the loan is secured by your home, you may be able to secure a lower interest rate than with unsecured borrowing options like personal loans or credit cards, which typically have higher rates for those with poor credit. Plus, the interest you pay on a cash-out refinance can be tax-deductible if used to improve your home, which could provide additional financial benefits.
However, there are some important considerations to keep in mind. Cash-out refinancing usually extends the term of your loan, which could mean paying more interest over the life of the loan despite a lower rate. There are also closing costs to consider, which can be substantial and should be weighed against the benefits of obtaining the cash-out.
Furthermore, since this option increases the amount of debt secured by your home, it’s vital to have a solid plan for how you’ll use the funds and how you’ll repay the loan. Failure to repay could put your home at risk of foreclosure. It’s also wise to consider the implications of potentially higher monthly payments on your budget, especially if your income is variable.
Get the Funds You Need Even with Poor Credit
Mutual of Omaha Mortgage offers a cash-out refinancing option, allowing homeowners to access their home equity and turn it into usable cash. This alternative solution provides numerous benefits over traditional options such as a Home Equity Line of Credit (HELOC).
With Mutual of Omaha Mortgage’s cash-out refinancing, homeowners can consolidate high-interest debt, remodel their homes, or cover urgent needs like medical bills and other significant purchases. To explore the benefits of cash-out refinancing with Mutual of Omaha Mortgage, simply fill out their short online form today.
