Getting a HELOC with bad credit is 100% possible, though it presents unique challenges. This comprehensive guide explains the requirements, strategies, and alternatives for securing a Home Equity Line of Credit even with a low credit score.
Common Reasons for HELOCs
Understanding why borrowers pursue HELOCs helps contextualize the importance of this financial tool:
Consolidation of High Interest Debt
A HELOC typically offers much lower interest rates compared to credit cards and unsecured loans. The difference in interest rates makes the HELOC an attractive product for the user because it enables debt to be consolidated and capital to be saved over the long term.
Home Improvements
Major improvements and renovations that can substantially change the value of the house could make a HELOC an attractive product. Major home repairs like roof repairs or HVAC replacements can also make the HELOC necessary. However, some lenders won't lend money if the collateral (the house) is not up to standard requirements.
Emergency Expenses
Medical bills, job loss, or any other financial emergencies can make the HELOC a necessary means to an end.
Minimum Credit Score for HELOC
Most HELOC lenders require a minimum credit score of 620, but most mortgage brokers can work around a low credit score depending on other metrics of the applicant's financial health. Loans are typically qualified on gross income, and if the homeowner has a paid-off house, they have strong leverage even with lower income.
Getting a HELOC with Bad Credit: Definition and Possibility
Bad credit in this context is considered a 580 FICO score or lower. It will be difficult to get a HELOC with sub-580 credit scores, but there are options available to help you secure financing.
Key Factors HELOC Lenders Consider
When evaluating borrowers with bad credit, lenders carefully assess multiple financial factors:
Home Equity
A homeowner with low credit typically requires an LTV (loan-to-value ratio) of 65%. For example, for a house where the owner is looking for a $500,000 loan, the appraisal would need to come in at about $770,000. This calculation isn't black and white, and other factors play into the loan as well.
Debt to Income Ratio (DTI)
Most lenders want DTI ratios no more than 40% usually, and with a low credit score (580 FICO Score), lenders will want below 30%.
Income and Employment
Stable income and regular employment are important when you have a low credit score because this gives the lender confidence that you will have income to pay back the loan.
Current Interest Rate
If you had the pleasure of refinancing or purchasing a house with a mortgage during the COVID pandemic and your interest rate is 2.75% to 3%, a HELOC is ill-advised. The low interest rates from the pandemic will never come back, so adding a second mortgage on your house via HELOC should be the last option you consider.
Is Pursuing a HELOC with Bad Credit a Good Idea?
Depending on the situation, it may be a bad idea. The borrower's credit score can make a big difference in rates and terms for the HELOC. If the situation is dire and the borrower needs the capital quickly, the HELOC may be the best way to remedy their situation.
Pros of HELOC
- Access to large amounts of capital by leveraging your house at relatively low rates compared to unsecured loans or credit cards
- Flexibility to draw funds as needed
- Potential tax deductions if funds are used for eligible home improvements
Cons of HELOC
- Higher interest rates due to bad credit
- Home serves as collateral—missing payments could risk losing your home to foreclosure
- Limited lender options and less favorable terms
How to Get a HELOC with Bad Credit
Follow these strategic steps to maximize your chances of approval:
Step 1: Check and Improve Your Credit
This should be step 1. Check your credit report and dispute any potential errors. A better credit score gives you more leverage and potentially a more favorable interest rate and more favorable terms.
Step 2: Consider Other Financial Metrics
If possible, pay down debt to reduce your DTI ratio and make yourself more attractive to lenders.
Step 3: Determine the Amount You Need to Borrow
Some lenders have a maximum loan-to-value ratio of 80%, but with a low credit score, this number is most likely 65%.
Step 4: Shop Around for Lenders
Contact credit unions, local banks, online lenders, and community banks. The smaller banks may be more willing to work with you if you have a lower credit score.
Step 5: Gather Necessary Documents
The typical HELOC application process usually takes 4-8 weeks and includes a home appraisal to confirm your property's value. You'll need:
- Pay stubs and tax returns
- Bank statements
- Employment verification
- Property tax statements and insurance information
Alternative Routes
If a HELOC isn't feasible, consider these alternatives:
Creditors Hardship Program
Contact your creditors for a hardship program and explain your situation. If this doesn't work, consider having a debt counseling/management service negotiate interest rates on your behalf.
Family/Friend Loan
This is likely a no-interest or lower-interest rate loan from a family member or friend. Avoiding banks altogether if possible is the best situation.
The Role of Professional Appraisals
Estimating Your Home Value
When applying for a HELOC, especially with bad credit, having an accurate appraisal is crucial. A professional appraisal establishes your home's current market value, which directly impacts how much you can borrow and the terms you'll receive.
The best tool I recommend people use to gauge your potential home value before an appraisal is "Wells Fargo Real Estate Estimator" or ask a Real Estate Agent that you know to pull potential comparables for your property. Some lenders also offer HELOC prequalifications with soft credit checks to see estimated offers without hurting your score.
Understanding your options and preparing thoroughly gives you the best chance of securing a HELOC even with challenging credit circumstances. Professional guidance from both lenders and licensed appraisers can help navigate this complex process successfully.
