How to Get a HELOC With Bad Credit

Thinking about tapping into your home equity to fund renovations or pay off high-interest debt? A home equity line of credit (HELOC) might be just what you need, offering access to the equity you’ve built up in your home at a relatively low interest rate.

But what if your credit score isn’t great? Don’t worry—it’s still possible to get a home equity line of credit with bad credit with the right approach. While lenders can be quite strict, even more so than with mortgages, it’s not an impossible task. Here’s how you can secure a HELOC, even with bad credit.

What is a Canadian home equity line of credit (HELOC)?

A home equity line of credit, or HELOC, is a revolving line of credit that uses your home as collateral. It allows you to borrow against the equity you’ve built up in your home. Your home’s equity is the portion of your property that you actually own. For instance, if your home is worth $1,00,000 and you still owe $400,000 on your mortgage, you own 60% of your home and have $600,000 in equity.

A HELOC works like a credit card, where you’re approved for a set amount—usually up to 65% of your home’s value—and you can draw from this line of credit as needed. Your home serves as collateral, making this a secured line of credit. However, you must have at least 20% or 35% equity in your home in order to qualify (depending on the type of HELOC you want), and your outstanding mortgage balance plus your HELOC cannot exceed 80% of your home’s value.

What credit score do you need for a home equity line of credit in Canada?

In Canada, the minimum credit score for a HELOC is usually around 620-650, but 700 or higher is better. However, this is just a general guideline, and each lender may have its own specific requirements. Some lenders may approve loans for people with credit scores below 620, but they might require the borrower to have more equity in their home and a lower debt-to-income ratio. However, these bad credit HELOCs will likely come with higher interest rates, smaller loan amounts, and shorter terms.

How to apply for a home equity line of credit with bad credit

Here’s how to apply for a line of credit with bad credit.

1. Check your credit report

Before applying for a HELOC with bad credit, take a moment to review your credit reports. You can get your report for free from TransUnion and Equifax. While it’s possible to get a HELOC with bad credit, improving your score beforehand can make a big difference. Look for and fix any errors, understand your score, and find ways to boost it. A better credit score not only helps you get a better rate but can also qualify you for a larger loan.

2. Calculate your debt-to-income (DTI) ratio

Lenders look at your debt-to-income (DTI) ratio to see if you can handle new monthly payments. Even with bad credit, a lower DTI can make you a more appealing candidate.

It’s easy to figure out. To calculate it, just divide your monthly debt payments by your gross monthly income.

Say you make $5,000 a month and have a $2,000 mortgage payment, a $175 student loan payment, and a $120 credit card payment.

• Monthly debt / Gross monthly income = ?

• $2,295 / $5,000 = 0.459 or 46%

This means your DTI ratio is 46%. An acceptable debt-to-income ratio generally falls between 40% and 50%, though this can vary from lender to lender.

3. Determine your equity level

When qualifying for a HELOC in Canada, lenders require you to have at least 20% or 35% equity in your home, depending on the type of HELOC. If you’re applying for a HELOC combined with a mortgage, you must have 20% equity. If you’re applying for a stand-alone HELOC, you’ll need 35%.

To estimate your home’s equity, subtract the remaining balance on your mortgage from your home’s value. But remember, your outstanding mortgage balance plus your HELOC cannot exceed 80% of your home’s value.

Let’s use the numbers from before. Say your home is worth $1,000,000, and you still owe $400,000 on your mortgage. First, we need to calculate the maximum loan-to-value (LTV) ratio.

• 1,000,000 x 0.80 = $800,000

Now, we take that maximum LTV ratio minus the remaining mortgage balance.

• 800,000 - 400,000 = $400,000.

Next, let’s make sure that it doesn’t exceed the 65% home value limit by dividing the $400,000 by the home’s value of $1,000,000.

400,000 / 1,000,000 = 0.4 or 40%

Because this is below the 65% home value limit, this means the maximum you can qualify for is a $400,000 HELOC.

4. Research HELOC lenders for those with bad credit

Some lenders are more open to working with homeowners who have bad credit, like Sub-Prime B Lenders. Subprime lending is usually based on your credit score. If your score is below a certain threshold (typically in the low 600s), you won’t qualify for prime interest rates from A Lenders and will need to look for lenders who offer subprime rates instead.

Private financing lenders can also offer home equity lines of credit, but they aren’t governed by federal regulations. These might be registered corporations or individual lenders who provide funds without strict qualifications like higher credit scores.

Choosing a lender that specializes in working with borrowers who have bad credit can increase your chances of getting your application approved. So, you’ll want to take the time to research and compare these lenders. Look for home equity lines of credit with lower interest rates, fees, and the best loan terms.

5. Write a letter to the lender

Having bad credit means you’ve likely made some mistakes in your credit history, resulting in a score under 620. This low score could be due to various factors, like missing or late credit card payments or mortgage payments, using more than 30% of your credit limit, or having a past bankruptcy.

One thing that might help your application is to write a letter to the lender explaining why your credit score is low, especially if it recently dropped. Clearly explain the issues you’ve faced and include any relevant documents.

For example, say your score has recently taken a hit because you lost your job and missed a few payments, but now you’re re-employed. Those missed payments will have a significant impact on your credit history, even if you’ve already paid them with your new income and are keeping up with your current bills. Or, say you co-signed a loan, and the borrower missed some payments. Because you co-signed it, it made you equally responsible, and those missed payments would have affected your credit score even though you weren’t the one paying for it.

These are things you can explain to the lender in your letter.

6. Submit your application

Once you’ve found a HELOC lender that fits your needs, submit your application. You’ll need to show proof of:

• Income

• Mortgage statements

• Home valuation

As part of your HELOC application, the lender will evaluate your home’s value to determine how much you can borrow. They will also review your credit score and check your income to assess your debt-to-income ratio. Your income helps confirm the monthly payments you can afford, making it easier to qualify.

How does a home equity line of credit work for someone with bad credit?

If you’re thinking about applying for a HELOC despite having poor credit, there are a few key points to keep in mind.

Your credit score is the main tool lenders use to gauge your creditworthiness. A low score often signals to them that you might have had some financial hiccups in the past. But don’t let that discourage you. Those past mistakes don’t necessarily block you from getting a loan; they might just affect the terms you’re offered.

You’ll see higher interest rates

Basically, if you have a lower credit score, expect higher interest rates. Lenders charge higher interest rates in Canada to individuals with poor credit to protect themselves. They see you as a riskier borrower, so they compensate by increasing the interest rates.

Keep in mind that the higher the interest rate, the more you’ll pay over the life of the loan.

You may need a co-signer

If your credit disqualifies you for a HELOC, having a co-signer with better credit might help in some cases. A co-signer can assist with credit and income issues for an applicant with a lower score. However, the main applicant still needs to meet the bank’s minimum credit score requirements.

Remember, a co-signer is equally responsible for repaying the loan, even if they don’t plan to make payments. If you miss payments, it will negatively impact both your credit and theirs.

Options for opening a home equity line of credit with bad credit

While the majority of HELOC lenders at traditional banks require a 620 credit score or higher, there are options out there for someone with a lower credit score. When looking for a HELOC, consider these options:

Online lenders

Online lenders are becoming more popular because they’re convenient and accessible, and some of them specialize in offering loans to people with lower credit scores. These lenders usually have faster approval processes and more lenient credit requirements. However, it’s important to carefully review the terms and conditions, as the interest rates and fees can be higher than those of traditional loans.

Credit unions

Credit unions are more community-focused financial institutions. They might be more open to working with people who have bad credit because they consider more than just credit scores. As such, they may be more likely to consider your ability to repay the loan or your current relationship with the credit union.

Private lenders

A private lender is any lender not associated with a traditional bank. These lenders are typically more flexible with their requirements and aren’t as restricted by regulations. They often accept borrowers that traditional financial institutions deny loans to due to poor credit scores.

Private lenders can be companies, groups, or even individuals, and their loans work similarly to those offered by banks. However, because they take on higher-risk borrowers, private lenders usually charge higher interest rates to protect themselves.

Having a co-signer

A co-signer is someone with better credit who agrees to take responsibility for your debt if you can’t repay it. Having a co-signer can boost your chances of getting approved and might even get you better interest rates or terms.

However, as we mentioned earlier, the co-signer is equally responsible for the loan, and their credit can be negatively affected if the primary borrower misses a payment. It’s important for both the borrower and the co-signer to understand their responsibilities to manage the credit line responsibly and avoid damaging their relationship and credit scores.

What to consider before applying for a home equity line of credit with bad credit

If you have a low credit score, taking on more credit can add extra stress to your finances. Ask yourself if the extra funds are worth the higher interest rates and stricter loan conditions you might face. Before applying for a home equity line of credit, consider these factors:

Consider the interest rates and fees

HELOCs usually come with variable interest rates, which can change over time based on market fluctuations. While variable rates can offer lower interest costs, even to someone with bad credit, they also bring the risk of higher payments if rates go up. Since there’s a good chance you’ll already be paying higher interest rates because of your bad credit score, you need to ask yourself whether you’d be able to afford even higher payments if your rates suddenly increased.

Besides interest rates, HELOCs often come with additional fees. These can include application fees, appraisal fees, annual fees, transaction fees, and more. You’ll want to compare the fee structures when looking at different home equity lenders to make sure you’re getting the best terms for your situation.

How well you can manage additional debt

When you get a HELOC, you’re only required to make monthly interest payments until the draw period ends. While this can seem ideal, it’s important to consider that in the long term, once the draw period ends, you’ll have to pay back the full principal amount (what you borrowed) plus the incurred interest.

The interest payments that you’re making on your HELOC during the draw period don’t go toward the actual amount of money you borrowed. This means it’s important that you start paying down your loan during the draw period.

Remember that HELOCs come with risks, and if you don’t repay what you owe, you could lose your home to your lender. That’s why it’s crucial to carefully consider your ability to repay before you apply. You need to ask yourself whether you can afford to make monthly payments toward both the interest and the principal amount.

Why do you want a HELOC?

Finally, you need to ask yourself: why do you want a HELOC?

If you’re just looking to apply for HELOC to pay for something like a vacation or a wedding, you need to ask yourself if that is really worth risking your home over. If you can’t afford to pay for things like this on your own, it may show that you may be trying to spend beyond your means. Remember, a HELOC is a form of debt, and using debt to fund your lifestyle is never a good idea.

Furthermore, while many people use a HELOC to pay off higher-interest debt, it may not address the real issue, such as not having enough income to afford the debt you’re in. In that case, it’s better to look into debt consolidation options instead. Using your line of credit to pay for debt you can’t afford only prolongs the inevitable.

Nevertheless, a home equity line of credit can be a great choice if you use it for home improvements that boost your property’s value. Plus, in a real financial emergency, a HELOC can also provide lower-interest cash compared to credit cards and personal loans.

Alternatives to a home equity line of credit

While having a HELOC can offer several benefits, if you have bad credit, you may need to look into other options.

Home equity loan

A home equity loan, also known as a second mortgage, works similarly to a personal loan, with fixed principal and interest payments over a set period. With home equity loans, you’ll have a fixed interest rate, and the loan will be secured by your home. Like with a HELOC, the amount you can borrow depends on your home’s value, your credit score, and your debt-to-income ratio.

Home equity loans are ideal for those who know exactly how much they want to borrow. However, unlike with a HELOC, where you can choose to just make interest-only payments, you’ll have more rigid monthly principal and interest payments.

Mortgage refinance

A mortgage refinance, also known as a cash-out refinance, can be a great alternative to a home equity loan. It replaces your existing mortgage with a new, larger one. Your closing costs are taken from the loan proceeds, and you can use the remaining money however you like. Plus, the interest rates are usually lower, and you get to pay off both the principal and interest over the life of your mortgage.

A mortgage refinance might be a better option than a HELOC if you can secure a better interest rate and prefer the stability of a fixed interest rate. Plus, you’ll only have one loan to pay back. However, if your new mortgage has a longer term, you might end up paying more interest over time, even at a lower rate.

0% introductory interest rate credit card

If you can get a credit card with a 0% introductory rate for a decent period, it can be a good alternative to a HELOC. These cards can be even cheaper than a HELOC, and the introductory period may be longer than the low-interest period offered by some HELOCs.

However, while you only need to make the minimum monthly payment, you should aim to make fixed payments large enough to pay off the entire balance before the introductory period ends. Otherwise, you’ll face very high-interest debt that’s hard to pay off. Plus, paying off the entire loan during the introductory period gives you much less time compared to a HELOC.

Personal loan

Finally, personal loans can be a good alternative to HELOCs. They can be unsecured, which usually means higher interest rates, or secured against something valuable, like your vehicle. Secured personal loans tend to be cheaper options compared to HELOCs.

However, keep in mind that if you opt for an unsecured personal loan, interest rates can be much higher than HELOCs, especially if your credit score isn’t great. Plus, they tend to have less flexible repayment terms, which can be harder to qualify for.

What’s the difference between a HELOC and a home equity loan?

Two popular ways to tap into your home’s value are with a home equity line of credit and a home equity loan. Both allow you to borrow money against your home’s equity and typically offer lower interest rates compared to other loans since your home is used as collateral.

HELOCs and home equity loans share some similarities—they are both secured loans that let you borrow money based on the equity you’ve built in your home. However, there are key differences.

A HELOC is a line of credit on your home, whereas a home equity loan is like a second mortgage. With a HELOC, you can borrow as needed, up to your maximum credit limit. In contrast, home equity loans provide a one-time lump sum that you repay over a set period with interest.

The interest rates for both HELOCs and home equity loans depend on factors like your home’s equity, the loan amount, and your credit history. However, unlike the variable rates of a HELOC, a home equity loan offers a fixed interest rate and term, making it easier to budget since your payments won’t change over time.

Lastly, with a HELOC, you’re only required to make interest payments during the draw period. With a home equity loan, you’ll make monthly payments toward both the principal and interest throughout the loan term.

The bottom line

Even if you have poor credit, you can still apply for a HELOC. However, you should be prepared for higher interest rates and stricter loan conditions.

If you’d like to qualify for better terms and interest rates, you may want to work on building up your credit score first. A higher credit score can offer significantly lower interest rates and a higher credit limit. And here’s how KOHO can help with that.

KOHO’s Credit Building tool makes it easy and secure to build your credit history. After you share some basic info, KOHO does a soft credit check and gives you a balance. They report this small amount of money as repayment history to the credit bureaus each month, which helps build your credit. You can even track your credit changes right in the KOHO app with free credit score checks.

KOHO Credit Building customers see their credit score increase an average of 22 points in as little as three months. Let KOHO help you rebuild your credit history safely and securely today!