Home equity finance is a great way for property owners to turn the unencumbered value of their home into cash. For homeowners with bad credit, these particular loans provide a way to borrow money that is more likely to get approved and offers lower interest rates than traditional loans or revolving credit lines. Why? First, the home serves as the security, or collateral, and second, equity in the property may make up for the shortfall in your credit history. This is especially true for homeowners who have a large amount of equity in their home.
The downside is that you can expect to attract less favorable terms on your home equity financing, and the financing will come at a higher cost. Two examples: You may be forced to borrow a lower amount to minimize risk to the lender, and more collateral (greater equity) may be required to secure it. Lenders typically lend up to 80% of a home’s equity value. However, the more equity you’ve established, the more appealing your application will be. Given that your home is being used as collateral, you will be viewed as a lower-risk candidate if you own 20% or more of your home. This can be particularly helpful when you have a poor credit score. Here is what you need to know to secure the financing you need.
Home-Equity Loans vs. HELOCs
There are two main types of home equity finance. The first is a home-equity loan, whereby a single lump sum is borrowed and repaid in regular installments, typically with a fixed interest rate over a period of 25 to 30 years. The second is a home equity line of credit (HELOC), where the lender authorizes the borrower to withdraw money as needed. Most HELOCs have an adjustable rate, interest-only payments and a 10-year “draw” period, during which the borrower can access the funds. After the draw period ends, the outstanding balance must be repaid over a repayment period (typically 15 years). (For additional insights, read and Choosing a Home-Equity Loan or Line of Credit.)
8 Steps to Home Equity Financing
Here are the steps you need to take to secure a home-equity loan or HELOC.
1. Study your credit report.
Get a copy of your credit report so you know exactly what you’re up against. (You’re entitled to a free one every year from credit reporting agencies: Experian, TransUnion and Equifax.) Check the report thoroughly to ensure there are no inaccuracies that are causing more harm to your score (you should do this routinely). (For more, see )
2. Prepare your financials.
Gather your financial information (such as proof of income and investments), so it’s ready to present to lending institutions. They’ll want to see in black and white that you’re financially stable enough to support your loan – especially if you’ve got bad credit. If possible, pay off any outstanding debt that could adversely impact your application.
3. Compare rates.
It’s logical to head straight to your existing lender for home equity finance – and given that you’re already a client, the lender may offer a more appealing rate. However, this isn’t guaranteed, particularly in the event that you have a bad credit report. The best rates are offered to those with good credit, so it always makes sense to shop around, particularly when poor credit is involved. Experts say it’s a good idea to work with a mortgage broker who can help you evaluate your choices and guide you to reputable lenders.
4. Consider how much cash you (really) need.
What is the purpose for which you are borrowing? And how much do you really need to borrow? It can be tempting to shoot for the stars to maximize your loan amount, perhaps to provide a financial cushion, but this comes with the temptation to spend it. If your spending habits are under control, it can make sense to “borrow up, ” and by using a HELOC, you’re only paying interest on funds as they’re spent. However, in the case of a home-equity loan, you’ll be paying full interest (and principal) on the entire loan lump sum, in which case it probably pays to borrow specifically for your needs.
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