Can You Secure a HELOC for Debt Consolidation w/ Bad Credit?

A home equity line of credit, or HELOC, provides homeowners with access to a revolving line of credit they can use for a variety of purposes. While HELOCs are often used to pay for home renovations they can also be a means of paying down debt.

When our Addition Financial members consider applying for a HELOC, bad credit may cause them to doubt their ability to qualify and take advantage of lower interest rates to consolidate their debt. The good news is that you don’t need to have perfect credit to get a HELOC to consolidate debt.

What is a home equity line of credit?

Let’s start with the basics. A home equity line of credit, HELOC for short, is a revolving line of credit that uses your equity in your home as collateral. For that reason, homeowners can only qualify for a HELOC if they have enough equity in their home to permit them to borrow against it. 

The primary difference between a HELOC and a home equity loan is that with a HELOC, you borrow only what you need and pay interest only on what you withdraw. For example, you might have a HELOC with a $100,000 limit but if you only borrow $20,000, you’ll only pay interest on $20,000. 

By contrast, a home equity loan consists of a lump-sum payment. If you took out a $100,000 home equity loan, you would receive the entire loan amount and pay interest on the entire amount.

Another key difference between HELOCs and home equity loans is that with a HELOC, you can borrow, repay, and borrow again during the withdrawal period. A home equity loan doesn’t allow for reborrowing.

What qualifications do you need for a HELOC?

Before we talk about whether you can qualify for a HELOC with bad credit, here are the basic qualifications for a HELOC:

• Pay stubs for the most 30 days for you and any other co-applicant
• W-2s for the most recent two years
• Proof of homeowners insurance
• Asset statements
• Tax returns for the past two years if you are self-employed or have income from rentals, bonuses, tips, or commissions

Some lenders have a minimal requirement for an applicant’s credit score, with 620 being a common minimum credit score, but Addition Financial does not have that requirement.

For many lenders, the maximum debt may not be more than 80% of the home’s appraised value. At Addition Financial, we will allow up to a 97% combined loan to value ratio (CLTV) for a HELOC in second position behind an Addition Financial mortgage.

Can you get a HELOC with bad credit?

If you’re considering applying for a home equity line of credit, poor credit may seem like an insurmountable obstacle. Here at Addition Financial, we consider it our mission to help our members work toward a bright financial future. We see what some people might describe as a bad credit score as an opportunity to help people get a handle on their finances.

That said, let’s talk about what most lenders would view as “bad” credit. In general, anything below a FICO score of 670 might be considered fair to poor, and a score below 600 is generally considered to be poor.

However, it’s important to keep in mind that your credit history isn’t the only factor that goes into qualifying for a HELOC. In some cases, a lender might be willing to approve you for a HELOC even with bad credit. Here are some circumstances that might help to offset a lower-than-desired credit score:

• A higher-than-usual percentage of equity. Many lenders are unwilling to offer a HELOC to anybody who has less than 20% equity. However, if you have a large percentage of equity, lenders are more likely to view your application favorably even if your credit score is less than ideal.
• A low debt-to-income ratio. A good benchmark for getting a HELOC is a debt-to-income ratio (DTI) of 47% or lower. The DTI compares the total amount of your monthly debt payments to your gross monthly income. So, if your monthly income were $10,000, most lenders would require that your total debt payments equal $4,700 or less per month.
• A low combined total loan-to-value ratio. As we noted above, many lenders don’t want to approve a HELOC unless the combined total loan-to-value ratio is 80% or less. If you have a decent amount of equity, you may be able to qualify for a HELOC with a less-than-ideal credit score if your CLTV is favorable.

We suggest crunching the numbers and reviewing your credit report to see if you have a realistic chance of qualifying for a HELOC. Keep in mind that if your home is worth more today than it was when you bought it, you may have more equity than you think.

Should you get a HELOC for debt consolidation?

If your credit score falls into the fair to bad range, then you might be wondering whether you should consider a HELOC for debt consolidation. Let’s look at the pros and cons.

Pros of HELOC for debt consolidation

Here are some potential advantages of using a HELOC for debt consolidation:

• One streamlined monthly debt payment. If you use a HELOC for debt consolidation, and particularly if you’ve been making multiple payments on multiple credit cards and debts, you’ll go from having multiple payments to having a single monthly debt payment. For many people, having a single debt payment is less stressful and more manageable than the alternative.
• You’ll pay a lower interest rate. It’s common for credit cards to have significantly higher interest rates than interest rates for a HELOC from a credit union or bank. A lower interest rate may translate to thousands of dollars of savings as you work to pay down your balance.
• You’ll have a lower monthly payment. The biggest immediate benefit of consolidating your debt with a HELOC is that, thanks to your lower interest rate, you’re also likely to have a total monthly debt payment that’s lower than what it was prior to debt consolidation.

For many people who are carrying debt, getting a HELOC translates to immediate relief from stress and a streamlined way to save money while repaying the withdrawal.

Cons of HELOC for debt consolidation

There are some potential downsides to using a HELOC for debt consolidation:

• Your home is collateral. When you get a HELOC, you’re using your equity in your home as collateral. That means if you fall behind on your payments, you’ll be at risk of losing your home. For that reason, it’s important to make sure that you have enough income to make the monthly payments on time.
• You may have to pay closing costs. Like loans, HELOCs have closing costs that may range from 2% to 5% of the HELOC borrowing limit. While some lenders may pay a portion of closing costs, others do not. It’s important to understand your financial responsibilities at the closing before you proceed.

We should also note that anybody taking out a HELOC for the purposes of debt consolidation should be wary of running up additional debt after consolidation. Your HELOC can help you get out of debt but it’s important to use it as part of an overall debt reduction strategy that will help you improve your financial situation.

Tips to prepare for the HELOC application process

Here are some quick pointers to help you prepare to apply for a HELOC to consolidate your debt:

1. Calculate your home’s equity. While your lender will order an appraisal to use during the underwriting process, you should have a handle on your equity before applying. You can use your loan balance and an estimate from a site like Zillow or Redfin to calculate how much equity you have.
2. Take an inventory of your debt. Make sure to include everything you have outstanding, including your mortgage, car loan, personal loans, student loans and credit card debt. You don’t have to use your HELOC to pay everything, but it’s still important to have a handle on what you owe.
3. Check your credit score. As we stated above, you can get a home equity line of credit with bad credit in some circumstances. It’s a good idea to review your credit report and correct any errors before you apply.
4. Get your paperwork in order. As a reminder, you’ll need your most recent month of pay stubs, the past two years of W-2 forms, an asset statement, proof of homeowners insurance and two years of tax returns if you have income from self-employment or from any source other than employment.
5. Be prepared to respond to questions. As your application moves through the underwriting process, be prepared for questions and respond to them as quickly as possible to avoid delays.
6. Talk to your lender about closing costs. 

There is a higher chance your HELOC application will go smoothly if you follow these steps.

If you have enough equity in your home, using a HELOC for debt consolidation makes sense. If you decide to apply for a home equity line of credit, bad credit shouldn’t stop you from applying. Your best bet is to choose a lender that will work with you to arrive at loan terms that you can afford.

Are you considering loan consolidation with a HELOC? Addition Financial is here to help! Click here to learn about our HELOCs and apply today.