Getting a loan when your credit score has taken a downward slide can be tough. Your home may hold the answer — with the value that it has accrued over time.
A home equity loan can allow a lump sum withdrawal of cash while a home equity line of credit provides as-you-need-it access. And a sky-high credit score isn't required for either option.
Check your debt-to-income ratio
Many borrowers can get a home equity loan or HELOC even with bad credit. That’s because you’re using your home to guarantee the loan. Lenders like having property as collateral, so they’ll work the "let’s get you approved" numbers a little harder.
“A debt-to-income ratio in the lower 40s or less will put you in the sweet spot for most lenders.”
Yet numbers still play a significant role. For example, to improve your chances of being approved and getting a lower interest rate, know your debt-to-income ratio. It’s what you owe divided by what you make. The NerdWallet DTI calculator can help you find your ratio.
A DTI in the lower 40s or less will put you in the sweet spot for most lenders. But if you shop around, you can find lenders that allow higher DTIs (higher debt).
It’s a balancing act between your credit score and your DTI. If you have a high DTI, it helps to have a higher credit score. A lower credit score might require a lower DTI. Ultimately, you have to be comfortable with your payment, and if your DTI is on the higher end, you may feel more stretched with money each month.
Find out how much home equity you have
Usually, you can borrow up to 80% — sometimes even up to 90% — of the value in your home. It’s another lending metric called the loan-to-value ratio. Here’s how it works:
Say your home's current market value is $300,000. You owe $200,000. Your LTV is 67%. If a lender allows you to borrow up to 80% LTV, you could pull $40,000 equity from your home:
$300,000 x 0.80 (80%) = $240,000 - $200,000 (what you still owe) = $40,000
This home equity loan calculator will do the math for you.
The key factors here are what you owe and the current market value of your home. It’s easy to know how much you still owe on the house — you can always call your mortgage holder for the balance. Knowing what your home is worth is another matter. Use this home value estimator to get an idea.
A lender will require an appraisal to nail down the official market value.
Know the credit score you’ll need
Most home equity lenders are looking for a FICO score of 620 or higher, but it’s all a matter of weighing your credit score against your loan-to-value and debt-to-income ratios.
However, credit scores count for a lot when determining your interest rate. Just look at how widely the interest rates vary in this FICO/rate chart.
Consider a cash-out refinance
If you think you’re on the border of approval for a home equity loan or HELOC, there is another option: a cash-out refinance. That’s taking your primary mortgage and reworking it — with a current or new lender — and taking some of your equity out as a part of the new loan.
It’s not a second mortgage, so lenders have even more leeway in underwriting the loan. You still have to have a good chunk of equity to make this work, but you may find it easier to qualify.
Remember to shop for lenders to find your best refinance option.
An alternative: Shared appreciation agreements
Now we’re thinking outside of the box.
Some companies offer "shared appreciation agreements." Here’s how that works: You get some of the equity in your home in exchange for giving an investment company a minor share of ownership in the property.
Generally, you give companies like Patch Homes, Point or Unison something like a 25% share of ownership for 10% of your equity.
"For most homeowners, this is an alternative to a HELOC or home equity loan," says Point co-founder Eoin Matthews. "We are able to underwrite to more forgiving standards, which means homeowners that might have substantial equity in their home but don’t qualify for a HELOC or home equity loan" can qualify for a shared appreciation agreement, he said.
However, shared appreciation agreements are complicated. And they aren’t cheap. Fees range from 2.5% to 3% and you’ll get less equity out of your home than with a home equity loan or HELOC.
They usually come with a 10-year term, too — meaning that’s when you have to pay back the equity the company gave you up front, plus a portion of your property’s appreciation.
How to get a home equity loan with bad credit
Calculate your debt-to-income ratio to see if you’re in the ballpark of the lower 40s or less
Learn what your home is currently worth and how much you still owe
Find out if your credit score is 620 or better
Consider a cash-out refinance — they’re generally easier to qualify for
Know that a shared appreciation agreement is another alternative