Home Equity Loans With Bad Credit: 3 Important Steps to Take Before Contacting a Lender

In the current economic conditions, bad credit seems to be a reality for many people. If you are worried that your poor credit score will impact your ability to find a home equity loan, you are wrong. In fact, despite the shaky economy, several lenders are willing to work with homeowners to get them the money needed to finance home improvement or anything else.

Home equity lines of credit are actually one of the best choices for those with bad credit scores to get money in times of need since they are secured loans. There are several steps that you need to take before talking to a lender about a home equity loan, however.

STEP 1: Talk to Your Initial Lender

Before you begin the process of finding a home equity loan (also known as a second mortgage) your first stop should be at the lender who initially financed your purchase. He can give you details about what you still owe as well as the amount of equity, that is, total money available, that you have on your home.

Your first lender may also be able to discuss the possibility of a refinance with you, if that route offers you a viable alternative to getting the money you need. Refinancing your current mortgage may be a good idea since, rather than making two payments on two mortgages, your first one and your home equity loan, you can continue to make one payment. Depending on how bad your credit score is, this may or may not be an option.

STEP 2: Check Your Credit

There are two important things that you should know before talking to a lender about your options for a second mortgage loan: your credit score and your credit report. First, you need to know your three digit credit score. This number, which will be between 300 and 800, tells the lender how creditworthy you are. Any score below 650 is "bad." Credit reports, on the other hand, tell the lender the details of why your credit score is low.

Make sure that you get a copy of your credit report and carefully review it. There may be mistakes on that report that are bringing your credit score down. The more actions you can take to improve that three digit score, the better off you will be in terms of finding a home equity loan.

STEP 3: Research Your Options

The final step you need to take involves getting to know potential lenders. Rather than calling them and getting a sales pitch, be sure to look through reputable resources for additional information about their business practices. The Better Business Bureau is a great first stop. This independent agency will rank the lenders you consider and give them a grade which is based on their past performances and customer satisfaction.

Similarly, looking at lending resource websites and talking to other borrowers about their experiences can provide additional insights on lenders to look out for and those whose practices are on the up and up. The quality of the lender you work with will directly impact the deal that you get and your ability to repay your home equity loan.

What Are Equity Home Loans?

Equity home loans allow you to take out a loan on the amount of equity that you have in your home. So, in the above example, you would look for equity home loans that totaled no more than $75,000, because the other $100,000 is still being used as collateral to back your original mortgage.

How to Get Equity

As you pay down the balance of your mortgage, you gain more equity in your home. You can also gain more equity if home values rise significantly. If you are purchasing a home, you can get instant equity by offering a price that is lower than current market value or by putting up a down payment. A 20 percent down payment will give you an instant $35,000 in equity on a $175,000 home. If you can snag that home for $150,000, then you will have an instant $55,000 in equity with a 20 percent down payment.

What Equity Home Loans Are & Aren't

A home equity loan is...

- Completely separate from your current mortgage.
- A way to borrow extra money using the value that you have in your home.
- An option only for people who have unleveraged equity in their home.

A home equity loan is not...

- An add-on to your current mortgage.
- An option for people who owe more than their home is worth.
- A way to refinance your current mortgage and get a lower monthly payment.

Leveraging Your Equity

You cannot leverage the equity in your home over and over. If you have $75,000 in equity and you take out a $75,000 home equity loan, then you will not be able to use your home's equity to get more money until you earn more equity by paying down your mortgage, paying down your home equity loan or unless your home gains more equity through rising home values. Once you have regained equity in your home, then you will be able to leverage it to borrow more money.

Equity Home Loans & Interest Rates

Remember that each new loan you take out may have a different interest rate, depending on your credit and debt-to-income ratio. If your credit has dropped or if you have a high debt-to-income ratio, then lenders may see you as a bigger risk and, in response, give you a higher interest rate.

Alternatives to Equity Home Loans

Equity home loans are not the only way to get money out of the equity that you have in your home. If you also need to get a lower interest rate or lengthen the life of your current mortgage, then cash out refinancing may be a better option than a home equity loan. This way, you will not only be able to borrow money, but you will also lower the monthly payments on your current mortgage.

With cash out refinancing, you refinance the amount that is left on your current loan and then take out extra money on your equity. Using our earlier example, you would refinance the $100,000 that you still owe on your mortgage, plus receive an additional amount up to $75,000 for the equity that you have in your home. This would all be rolled into one loan, with one payment every month.

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