Can I Use Home Equity With Bad Credit?

Homeownership By Noah - Updated on March 9, 2022

Three little digits can have a powerful impact on your overall financial life. Your credit score is a major factor lenders consider when you apply for a loan. Getting a home equity loan with bad credit can be tough, which is especially frustrating for homeowners who hope to tap home equity to clear other debts and get on steadier financial footing.

If you’re trying to figure out if you can get a home equity loan or home equity line of credit with a bad credit score, we can help demystify what lenders are looking for. You may even find that financing options with different credit and home equity requirements work better for you than a traditional loan.

What Credit Score Is Too Low?

It can be tough to pinpoint the line between “good” and “bad” credit. Technically, the lowest a FICO credit score can go is 300, but almost no one hits this rock bottom. Most people’s credit scores fall somewhere between 600 and 750. According to Sahil Gupta, co-founder of Noah, many Noah homeowners falls right in the middle of this range, with credit scores around 650-700.

Lenders set their own requirements for minimum credit score to work with a borrower, which can make it tough to gauge the “bad credit” cutoff. Many HELOCs require at least a 680 to qualify. While some home equity loans may still be available for borrowers with a credit score as low as 620, the interest rates are likely to increase steeply as scores drop below the high 600s.

All things considered, it’s reasonable to say that around 670 or 680 is when a credit score starts becoming an issue for many traditional lenders. It’s not necessarily the cutoff point for qualification (although in some cases it may be), but borrowers below these scores can typically expect less favorable terms, such as smaller loan amounts and higher interest rates.

Why Lenders Are Strict About HELOC Credit Requirements

Lenders look at a few factors in your financial profile to assess whether they’ll approve your application and what terms they will offer you:

  • Loan-to-value ratio (LTV), or how much equity you have in your home
  • Debt-to-income ratio (DTI)
  • Credit score
  • Payment history
  • Income

Borrowers who own their own businesses or work as 1099 contractors may face even more requirements.

“The challenge for 1099 contractors and business owners is that their income profiles are inconsistent in nature. Due to the nature of the work, they may get paid varied amounts each month. As a result, computing their income is not as straightforward as a W-2 employee who gets paid the same amount each month and has more predictability,” Gupta said.

As a result, lenders often ask for several years’ worth of bank statements and tax returns and may even factor in a discount in case the borrower has a lean year. This can lead to an applicant profile ending up with a conservatively calculated DTI that looks less favorable than might really be the case (after all, the applicant could also have a business boom).

Some mortgage lenders may be okay with a 43% or even 50% DTI ratio for borrowers, while others won’t work with someone with higher than 36% DTI. Credit matters a lot because lenders want assurance that borrowers will make second mortgage payments faithfully over the life of the loan.

Many lenders have also become more strict due to pandemic-related economic challenges. It’s been a volatile time for individuals and businesses, and approving loans means taking on risk. Some lending institutions have frozen HELOC applications or raised credit score requirements altogether. Homeowners in need of home equity funding may have to look to alternate options.

“Noah is different from traditional lenders in that it takes a holistic approach to underwriting and its investment in the home. In terms of credit and income, Noah invests in FICO scores as low as 600 and DTI ratio up to 60%,” Gupta said. This is in part because Home Equity Access from Noah does not require monthly payments.

Will a Home Equity Loan Hurt Your Credit?

If your credit score is currently low, you may be understandably concerned about any actions that could lower it further. It’s true that a home equity loan can affect your credit score, but usually the impact isn’t severe. Home equity loan borrowers see an average drop of about 13 points on their credit score. That’s largely due to the fact that the loan adds to your overall debt burden. Most borrowers see this negative impact reverse in less than a year.

Of course, how you manage home equity loan or HELOC debt can have a much bigger impact on your credit. Falling behind on payments can damage your credit. HELOCs are a variable-rate product, meaning your interest rates are subject to change. That can substantially change how much your monthly payment could be. While in principle, you can borrow from a HELOC multiple times and pay it off (almost like a credit card), in practice, a HELOC lender often has the right to put a hold on your ability to draw from from the line of credit. That means if they see warning flags, such as changes in your financial situation, they may freeze your ability to borrow additional funds. That of course presents challenges, because you may need the funds from your home equity more than ever! 

Noah’s Home Equity Access doesn’t count as a loan on your financial profile, and you can get an initial estimate without any impact on your credit. Your DTI ratio won’t be affected by the Noah financing agreement (in fact, it’s fairly common for people to use the upfront funds received through Noah to pay off credit card debt and reduce their DTI). Noah doesn’t set a monthly repayment schedule, which can also make it easier for some homeowners to set their own savings plan without worrying that a tight month could turn into a missed payment and hurt their credit.

Home Financing With Low Credit

According to Gupta, many homeowners he meets through Noah find themselves with less than optimal credit. Many families find themselves with debt due to falling behind on high-interest credit cards or personal loans, or face medical or family events that lead to them falling behind on payments.

It can be possible to draw from home equity using a traditional home equity loan even if you have poor credit, but you’re likely to face stricter limitations on how much you can borrow. Your interest rates will also be higher, and ultimately you may risk foreclosure if you can’t keep up with monthly payments.

Can you get a home equity loan with a 500 credit score?

Some homeowners have gone through tough times and ended up with a very low credit score, well below 600. If you’re hoping to get home financing with a low credit score, talk to a mortgage broker about what options exist.

One possible option to consider is an FHA cash-out refinance, which may be available for borrowers with a credit score as low as 580 (although lenders can set their own requirements higher). Unfortunately, it’s challenging in most cases to get home financing with a 500 or 550 credit score. If you can work on your credit until you have at least a 580 FICO score, you may be eligible for Noah's Home Equity Access before other lenders are ready to approve you.

How to improve your credit score quickly

Good credit has the ability to increase your loan options. Here are a few steps you can take in order to raise your credit score:

  • Get your free credit report from all three major credit bureaus
  • Dispute incorrect entries and have them removed if possible
  • Make a firm commitment to pay at least the minimum balance on all credit accounts on time or early every month
  • Lower your credit utilization
  • Consider keeping credit accounts open – especially older accounts – for the time being, as length of credit history can positively impact your score

Depending on your situation, you may see an improvement in your credit score in a short time. If you are able to dispute and remove erroneous entries, you may see that change reflected in about 30 days. Other changes can take longer, but timely payment can make a big difference to your credit over time.

Alternate home equity financing for low-credit borrowers

Ask your mortgage broker about financing alternatives that don’t weigh credit as heavily. A broker that’s partnered with a referral program like Noah’s may be able to walk you through advantages and disadvantages, and even help you complete and submit paperwork if you find a financing option that looks like the right fit.

“We believe that homeowners should always explore all available options to them, independent of their financial profile. Remember, many of the traditional products of today were once considered alternatives themselves,” Gupta said. “Homeowners should focus on their goals when considering any financial offering.”

Home equity sharing agreements like Noah carry a couple important benefits for homeowners. For one, Noah can often assess a homeowner’s financial profile differently than some traditional lenders, making it easier to work with people whose credit isn’t in strong shape. Another major advantage is that Noah doesn’t put an immediate financial burden onto homeowners. Traditional home equity loans and HELOC options are structured to require monthly repayments right away and add interest to the principal debt. If homeowners are having a hard time paying off other debts, adding more bills and interest could strain an already difficult financial situation.

Especially considering that some banks and lending institutions aren’t offering as many HELOCs at the moment, a mortgage broker can be a good resource to point you to other ways to access your home equity and get started repairing your finances and creditworthiness.

Bad credit can happen to almost anyone, but credit doesn’t tell your whole story. Be open to considering various approaches and talk to professionals like your financial advisor or mortgage broker, and you may be able to access home equity financing to jump-start your financial improvement plans.