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Getting a Home Equity Loan Despite Bad Credit

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Have you ever thought of taking out a home equity loan or line of credit? If you are facing a big expense - like college tuition or home repairs - and you own your home, a home equity loan might make sense. But you may also be worried about your credit score. You suspect that you have some history of bad credit - perhaps some late credit card payments or an unpaid student loan. You think that if you have bad credit, you can't get a home equity loan.

Home Equity Loans

What is a home equity loan? To best understand the concept of a home equity loan let's look at the following scenario. You own your own home and for ten years you've been paying your mortgage on time. During this period you have built up equity in your home, which means that you are a part owner together with your lender. If you bought your house ten years ago for $300,000 and your down payment was $45,000, the amount of equity you have in your house is the down payment ($45,000) plus the principle you have paid (say, $15,000); this equals $60,000. But there is one more factor: the current appraised value of your home. For simplicity sake, let's assume that even in this recession your home has held its value and is worth $300,000.

In theory, you could access a portion of your $60,000 equity for a home equity loan or a home equity line of credit. But what if you have bad credit?

When you apply for a home equity loan, the lender will take many factors into consideration when determining how much to lend you and at what price. With bad credit, it may not be a question of whether or not you can get a home equity loan but how much it will cost you.

A major factor in the lender's decision is your credit history. Today there are three major credit reporting agencies. These are Equifax, Experian, and Trans Union. Under the Fair Credit Reporting Act (FCRA) and the Fair and Accurate Credit Transactions (FACT) Act you are entitled to view your credit reports at no charge once a year. Do not contact the agencies directly; to learn about how to access your credit reports go to the website of the Federal Trade Commission and click on Consumer Protection. Alternatively, check out our article on how to obtain a free credit report.

The three credit bureaus most often use the FICO score system, which assigns each consumer a number rank between 300 and 850. Higher scores (above 700) are good. Lower scores (below 600) are bad. The lower your score, the less money you can borrow and the higher interest rate you will pay.

What Can Affect Your Credit Score?

Many factors that seem obvious will affect your credit score, including missed or late credit card payments. But there are other things that can bring down your score too.

  • How often your credit history is accessed. That's right: every time a potential lender checks your credit history, this fact becomes part of your record. If your credit records are being checked too often, lenders see this as a red flag. Why? Because it may mean that you are "shopping around" for credit and are being turned down. A lender may think that you are a high risk.
  • A short credit file makes you less desirable. Some consumers (wisely, they think) refrain from using very much credit. They may have only one credit card, which they don't use very often. This is fine until they try to access a bigger loan, such as a home equity loan. A lender may see this customer's lack of credit history as a higher risk and charge more for the loan.

If you want to get a home equity loan or line of credit, be aware that because of the current recession many lenders are tightening their requirements. Your bad credit may be a factor if you are denied. But you have rights; under federal law, if a lender takes adverse action against you (such as denying your application for credit or charging you a high interest rate), you are entitled to a free explanatory report. You must request your report within sixty days of the decision.