Making home improvements can get expensive. One of the best ways to pay for them, aside from cash, is with a home improvement loan. You borrow from the equity of your home and you invest right back in your home. It’s a perfect scenario because you will likely increase the value of your home, making the money right back.
What if you have bad credit, though? Will banks approve your request for a home improvement loan?
Unlike when you bought your home, there are fewer programs for home improvement loans with bad credit. Home improvement loans usually have second lien position. This puts the lender in a risky situation. If they lend money to someone with bad credit, the situation becomes even riskier. So can you do?
Luckily, you have a few options.
FHA 203K Loan
The FHA has a program that helps borrowers improve their home even with ‘bad credit.’ Just like their standard purchase loan, the FHA allows credit scores as low as 580. They also only require 3.5% equity in the home.
The FHA 203K loan is actually a first mortgage, though. With this program, you can borrow enough money to pay off your first mortgage and fix up your home. You can borrow up to 110% of the improved value of your home. The lender can determine the improved value after you provide details of the improvements you will make. These details include contracts and blueprints from contractors. The lender will then consult with a professional appraiser to see how much you can borrow.
The first portion of the FHA 203K pays off your first mortgage. The lender then puts the remaining funds in an escrow account. The lender then disburses the funds as scheduled with the contractor.
You have two options for the FHA 203K loan:
- FHA 203K Streamline – You can make cosmetic and non-structural changes to your home with this loan. You can borrow up to $35,000.
- FHA 203K – You can make any changes to your home with this loan with lender approval. The minimum you can borrow is $5,000, but the maximum is dependent on the after-repaired value of the home.
Home Equity Loans
Home equity loans aren’t regulated by Fannie Mae or Freddie Mac. Each lender has their own program, which may mean that some allow lower credit scores. Home equity lenders often base the risk on the amount of equity you have in the home. This equity becomes the lender’s collateral. The more equity you have, the higher your chances are of securing a HELOC or home equity loan.
It helps if you have compensating factors. A large amount of equity is the best compensating factor because it’s the lender’s collateral. Aside from equity, if you can show the lender any of the following, it will increase your chances of approval:
- Low debt ratio – Your debt ratio is a measure of your expenses versus your gross monthly income. The fewer expenses you have, the lower your DTI becomes. This puts the lender in a better position. The more expenses you have, the harder it may be to pay your home equity loan, which could put the lender in a bad position.
- Stable income/employment – Lenders look at the history of your income and employment. Are they steady or do you hop from job to job? Did your income fluctuate a lot over the last two years or did it remain steady? The more consistent both your income and employment are, the better your chances of loan approval even with bad credit.
- Reserves – Even though you are applying for a home equity loan to get money to pay for your home renovations, reserves on hand can help. It shows lenders that you can save money and that you have money available should something change with your job and/or income. You can count any money you have in your checking, savings, stocks, bonds, or mutual funds as liquid reserves.
If the FHA 203K or home equity loan options aren’t for you, try a personal loan. Today, you can get personal loans from many places including banks, credit unions, and online lenders. You don’t have to rely on the strict guidelines of your local bank any longer. If you jump online, you can find a large number of private lenders and even individuals willing to invest in your loan.
Peer-to-peer lenders are individual investors that work through a third-party company to facilitate the loan. You may receive all of the funds you need from one investor or it could be a combination of investors that make up your loan. Either way, you make one monthly payment to the servicer of the loan.
The qualifying requirements will vary by lender, whether you go to a physical bank or you apply for a personal loan online with individual investors. You may have to shop around until you find a lender willing to give you a loan based on your qualifying factors.
Fixing Your Bad Credit
If you can’t find a lender to approve your loan when you have bad credit, you can try to fix your credit and get the loan you need using the following tips:
- Check your credit report for accuracy – Get a copy of your free credit report and make sure all trade lines belong to you and show the proper information. Human error happens, but when it does, it can damage your credit score.
- Get current on your bills – If you have late payments reporting on your credit report, bring your accounts current. Then you must continue to make your payments on time to get your credit score to increase.
- Lower your utilization ratio – If you have a lot of outstanding credit card debt, it can have a damaging effect on your credit score. Try to pay your debts down or off entirely. The less revolving debt you have outstanding, the higher your credit score may go.
- Create a good mix of credit – Your credit score is also dependent on the type of credit you have. If you have all revolving debt, your credit score will suffer. If you have a good mix of revolving and installment debt, your score may increase.
The most important thing is to stay consistent. Your credit score won’t improve overnight. Good habits take a while to reflect in your credit score. Lenders, whether traditional mortgage lenders, credit unions, or individuals will notice these habits and reward you appropriately with a home improvement loan to help you increase your home’s value.