Those who want to apply for a bad credit home equity loan may follow these steps to make a formal application:
Step 1: Check your credit report & improve it
Before seeking a bad credit loan, borrowers can order a free credit report from one of the 3 major credit bureaus. The credit report will paint a complete picture of the borrower’s credit score. Credit reports list out every credit transaction that goes into the credit score. This way, borrowers can see exactly why their score is what it is.
In some cases, borrowers decide to improve their score before applying for a home equity loan. This can help them secure better rates and terms. In some cases, borrowers notice errors in their credit reports. It’s easy and free to report an erroneous entry on a credit report. Having a negative, erroneous entry corrected can also improve the borrowers’ credit score.
Step 2: Evaluate your debt-to-income ratio
The debt-to-income ratio is meant to measure each loan applicant’s total debt balance with their income. It is a simple, percentage-based metric that represents another risk of lending. For example, if you have an income of $80,000 and have a total of $20,000 in debt, your debt-to-income ratio is 25%.
The main benchmark for a debt-to-income ratio is 43%. A ratio any higher than that will be considered high-risk to the point that many lenders would reject the borrower’s application. Some lenders will loan money to those with a ratio of up to 50%, though.
Paying off debt is the only way to reduce a debt-to-income ratio. If possible, some borrowers may opt to lower their debt-to-income ratio before seeking loans. As in step 1, this may broaden the borrower’s options.
Step 3: Find out how much equity you have on your home
Home equity is the fair market value of your home divided by the principal balance of your mortgage. For example, if your home is worth $400,000 and you owe $300,000 in mortgage principal, you have 25% equity in your home.
For borrowers seeking a home equity loan, knowing the equity they have in their home, both as a figure and a percentage, is important. Lenders are happier to deal with people who have more equity. However, the percentage of equity is important in evaluating the risk of the loan.
It’s usually considered better practice to seek a home equity loan when the borrower’s equity in their home is stronger.
Step 4: Consider how much you need
Even when all the above factors are strong for a borrower, it doesn’t pay to borrow more than one needs. Borrowers can be more successful with loans by carefully considering the cost of their expenses and borrowing accordingly. Then, the borrower can cover the entire intended cost of an expense while being prepared to pay the loan back.
Step 5: Compare interest rates
A home equity loan’s interest rate is the most significant factor in determining its cost. Loans can have several closing costs and other costs. However, those are normally far less significant than the interest rate. The interest rate of a home equity loan is the percentage that the borrower must pay back in order to take the loan. Interest is paid back first, followed by the loan’s principal.
Comparing interest rates and getting the best rate possible (given the borrower’s creditworthiness) is one way to potentially save money. An interest rate that is just half a percent lower can easily equal hundreds of dollars for home loan products.
Step 6: Use a co-signer
Borrowers with bad credit can put themselves in a better position to borrow by finding a cosigner. A cosigner is someone who lends their creditworthiness by serving as the guarantor for a loan. Of course, the cosigner will be made to understand the risks in guaranteeing a borrower’s loan before cosigning.
For a cosigner to save a borrower more money, it may be easier if they have a high credit score, a stable income, and other markers of creditworthiness.
Step 7: Boost your credit
Borrowers can prepare for the loan comparison and application processes by first boosting their credit. Borrowers can boost their credit over the course of a few months by:
- Checking their credit report
- Paying their bills on time each month
- Not closing credit cards after paying them off
- Not maxing out or opening new credit cards
- Paying down credit card debt