You might think that there aren’t many people who have a lot of equity in their home – and also have credit issues. After all, you have to get approved for a mortgage and then make regular payments on that mortgage for the better part of a decade to build up the level of equity that would make a loan against it worth the fees.
However, a lot of people run into financial difficulties after they have been making their mortgage payments for a long time. Sometimes it’s a medical condition that keeps one of the two income earners in the home from being able to earn a salary, and the family depended on both salaries to make ends meet. There are also the costs associated with treatment of that condition, so you can get into a situation where you’re bleeding cash but you’re making that mortgage payment every month – after all, you need a place to live. So over time your house can aggregate a ton of equity, but your credit can suffer, as you run up big credit card balances and bounce around from missing one card payment to a car payment, getting to the point where all of your creditors seem like they’re hounding you at once.
Take out equity with bad credit
When you have bad credit and need money, your options shrink considerably, but the interest rates associated with those options increase. The equity in your home might be the only way for you to get a loan at all (if your credit is bad enough), or (if your credit is a little better) it might be the cheapest way for you to get a loan on the basis of interest rates.
If you decide to take out equity with bad credit, you can face terms that are less favorable than you would if your credit were more pristine. The amount of the loan is likely to be smaller, even if you have significant equity, because your lender wants to minimize risk, which means that they want the home to serve as collateral for that smaller amount. Lenders will often take you up as high as 75% loan-to-value ratios on a home equity loan (which means that if you have a home that appraises at $400,000, you can take a loan that will push your total balance owed on the home as high as $300,000). But how do you know what is the best option for you?
Loans against the equity in your home come in one of two forms: a traditional home equity loan and a home equity line of credit (HELOC). A traditional home equity loan comes to you in a lump sum. You pay back that sum with interest in regular monthly or quarterly payments. A HELOC is an authorization for you to withdraw money from that credit line as you need it. While the home equity loan will likely offer a fixed interest rate, the HELOC often comes with an adjustable rate and offers a “draw period” during which you can take out the money. Once the draw period ends, you pay back any balance with interest over a set term.
So how do you get started with home equity financing, whether it’s a loan or a HELOC?
Take a look at your credit report.
The credit bureaus have to provide you with a free copy of your report once a year. No matter what your credit score is, check all of the accounts on there. If any of them are erroneous, challenge them with the bureau. The bureaus are required by law to check any reports of errors.
Pull together your bank reports and other statements.
You’ll need three to twelve months of bank statements, as well as account statements from any other assets that you plan to list as support for your application. Bring in at least the last three months of your pay stubs from work. If you have bad credit, the bank wants to see that your income is stable enough to support this new payment. If you can, pay off any debt that could keep you from qualifying.
Shop the loan around (wisely)
Don’t sign the paperwork on the first loan offer you receive from your bank. Ideally, get in touch with a brokerage firm that can look at options for you. By you going to multiple banks, you will receive multiple inquires on your credit which could lower your score. Working with a brokerage firm prevents such multiple credit checks from occurring.
Carefully consider your cash needs.
Why are you taking out the home equity loan? How much do you need? (And remember, there’s a difference between what you would like and what you would really need). You might want to take out the maximum for which you are approved, but then you have to pay back the interest on that if you do a traditional loan. Instead, you might think of using a HELOC. That way the money is there if you need it, but you don’t have to pay interest on it if you actually use it.
Consider using a co-signer.
If your credit is shaky, then think about having a co-signer for your mortgage. You get to use the co-signer’s credit history and income on the loan as well as your own – so make sure you choose someone whom you trust (and who trusts you), and who has income and credit that will improve your application.
Work on improving your credit score.
If you don’t need the money immediately but could wait for two or three months, you have time to get your credit score to a point that is more favorable for your application. Now it’s time to challenge any creditor items that you think are incorrect and to make some payments on debt to bring those items current.
Finally, remember that if you take out a home equity loan, you are adding to the debt that you have on your property. Now you have more money to pay to lenders each month, and if you have two separate loans now, you have two creditors that could foreclose on your house if you fall behind. So make sure that you can take on this debt.
More question? Call Amansad Financial. We’ll go over your individual situation and make recommendations for the best options for you. We have access to 3rd party credit improvement companies to help you fast track your credit improvement if time is on your side.