Bad Credit, No Credit, No Chance The Difference Between a Home Equity Line of Credit (HELOC) and a Home Equity Loan

You've heard the mortgage lenders barking their bad credit, no credit loans on television and radio. "Even if you have been turned down by another lender, you will be accepted by XYZ mortgage no matter what kind of credit history you have or what crime you've committed. We refuse no one because everyone is human, subject to bad breaks once and awhile. Why should you be penalized for circumstances beyond your control." Their pitch sounds too good to be true, and oftentimes it is.

Bad credit, no credit loan programs are primarily aimed at people with bad or no credit history. In exchange for the added risk a lender assumes on the loan, the borrower usually pays a sub-prime, higher interest rate. Common sense should remind the borrower with bad credit that applying for future credit gets harder, not easier. Repairing ones credit history should be paramount to re-entering the conventional credit and mortgage loan market.

Most people with a bad or no credit history should be fortunate that such loan programs exist. But they should also realize that such loans usually carry high interest rates and/or points. (A point is one percent of $200,000 or $2,000.)

A typical profile of a bad credit risk would be the following:

DTI (debt to income ratio) of 50% or higher
FICO (credit history) score of 620 or lower
Low LTV (loan to value ratio)
Little to no discretionary income
Bankruptcy within past 60 months
Two or more 30-day delinquencies over the past 12 months
One 60-day delinquency over the past 24 months
Foreclosure over the past 24 months
Some mortgage lender spokesmen claim that current rates for bad credit risks are the same as good credit risks and that times have changed for the credit compromised borrower. But it's not as easy as they claim. Borrowers should be aware of the differences between ethical and less than ethical lenders. Some unethical lenders use predatory practices that corner the borrower and saddle him with excessive rates or points.

The borrower has recourse against less than scrupulous lenders. The Home Ownership and Equity Protection Act of 1994 protects the borrower from lender malpractice. This act provides legal protection for the borrower in case the lender is found to have used deception and misrepresentation in the act of selling a loan. The Truth in Lending Act (TILA) sets new rules and regulations against lenders attaching excessive high rates and fees to certain types of loans.

It seems that more of these bad credit, no credit loan programs are populating the airwaves with claims of instant mortgages for borrowers. But just as the lender should beware of exposure to bad credit risks, the borrower should also beware of lenders with usurious or excessive rates tied to high-risk loans.



Acting much like a second home mortgage (but often with lower interest rates) a home equity loan is a program which offers a homeowner up to 85% of their home's current equity in the form of a large sum loan. Interest is accrued and a monthly payment structure is set up, just like a standard mortgage loan. Yet instead of a standard home loan, money from a home equity loan can in most instances be used to pay for anything: home remodeling, college tuition costs, medical bills, business expenses, a new car, family vacation ... In most programs, there are no restrictions. And to apply, homeowners must only submit to a credit check and pay for the bank or lending institution to perform a home appraisal. Other fees and requirements may apply, but are usually nominal.

A home equity line of credit (HELOC) is granted using the same percentage system as a home equity loan and requires the same documentation-credit check, home appraisal-yet a HELOC is issued in the form of a credit card or checkbook with a limit (much like a standard credit card account). While some lenders issue annual HELOC fees for having an account open, others simply charge as you spend the money, with accrued interest. Therefore, your monthly payments differ based on the amount you have spent. As you pay down the limit, more funds become available, and so on. And, just like the home equity loan, most home equity lines of credit allow borrowers to use the money for whatever they wish.

Pros and Cons

Home equity loans have been hailed as one of the most flexible and desirable lump sum loan programs, primarily because of the low interest rates and tax advantages. Yet they are perhaps the most advantageous to those who need a lot of money and fast-such as for a short-term, large-scale project or medical bills.

HELOCs, on the other hand, are best utilized by people who might need a large amount of money over a span of time-such as college tuition or home remodeling projects that require long-term payments. HELOCs act in much the same ways as credit cards-but with a few distinct advantages. First and foremost are the interest rates, which are often much, much lower than standard credit card fees and rates. Home equity line of credit rates begin at an interest rate that is less than prime, while credit card rates have been known to reach into the upper 20th percentile. That's a big difference.

Perhaps this is why home equity loans and home equity lines of credit have become such popular forms of debt consolidation programs. Credit card debt can be paid off with the low interest rate from a home equity loan or home equity line of credit, and then wrapped up into their low interest monthly payment.

Lastly, a considerable advantage for both HELOCs and home equity loans is that they can have tax advantages, including deductible interest. (Check with your tax accountant or CPA for more information.)

The downside to both loan programs is that they use your home as collateral, meaning that if you default on the loan for any reason, your home could be put at risk. Be sure that you're financially able to at least make the minimum monthly payments before signing up for such a program-regardless of how good it might sound.