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Now that you have paid off your house, getting a new loan should be more realistic – even if you have bad credit history appearing on your consumer report.

Lenders weigh your FICO or Vantage score, and a record filled with delinquency, defaults, and collection accounts hurts your cause. However, banks and finance companies consider other criteria, as well.

First, your Debt-to-Income (DTI) ratio immediately improves the moment your mortgage balance reaches zero. Also, your prospective Loan-to-Value (LTV) is at an optimal point.

Compare the pros and cons of unsecured and secured loan options and decide which route works best for your situation.

Personal Loans with Bad Credit

Personal loans are a viable place to turn for funding when you have no mortgage but a lousy credit history. Unsecured contracts do not require you to pledge the equity in your home as collateral, which has advantages and disadvantages.

It’s easy to get a personal loan (Affiliate Link) without a hefty mortgage payment weighing you down, your Debt-to-Income (DTI = Monthly Payments/Monthly Debt Service) ratio shines, improving your affordability qualifications!

Monthly Debt ServiceMonthly Income

Mortgage (Zero)

Job Employment

Homeowner Insurance

Self-Employment

Property Taxes

Alimony

Automotive

Child Support

Credit Cards

Disability Benefits

Installment Contracts

Unemployment Compensation

Pros

The primary advantage of taking out an unsecured personal loan when you own your house outright is that you minimize the possibility of a foreclosure down the road. People with a bad credit history are more likely to experience future financial hardship, so the ability to stay in your home is a critical consideration.

Compare the consequences of default.

  • Unsecured personal loan: lenders must file a lawsuit in court, and the resulting judgment could result in garnished wages or a lien against your home, which executes when you choose the sell the property
  • Secured home loan: lenders can foreclose without filing suit to recoup losses by selling or taking ownership of your property when they decide the time is right

A secondary benefit of unsecured personal loans is a streamlined underwriting process. You do not have to incur costly appraisals or intrusive home inspections because the lender relies on your signature promise to pay.

Cons

The most significant negatives to unsecured personal loans are the less favorable borrowing terms. People who retired their mortgage balance while being delinquent (poor credit) with other obligations at the same time have lived the drill and should understand why.

Consumers dealing with financial hardship often pay their secured contracts first for fear of losing their home to foreclosure or their car to repossession. Meanwhile, defaulting on an unsecured revolving account or installment loan has consequences that are tamer by comparison.

Therefore, be prepared for less desirable offers that minimize lender risks. 

  • The borrowing limits are often much smaller
  • The repayment terms could be shorter (5 years or less)
  • The financing charges could be higher (origination fees, interest rates)

Borrowing Against Paid-Off House

Borrowing against a paid-off house is much easier because the value of your collateral is much higher. Your equity equals the market price of your real estate, as verified by an independent appraisal because the balance owed on the mortgage is zero.

People with bad credit history often find they qualify more readily for secured contracts – where you pledge the house as collateral. However, you reintroduce the risk of foreclosure in the event of future default.

Home Equity

The minimum credit score for a home equity loan is much lower when you own the property outright, making it easier for people with low ratings to qualify. Most lenders will require a credit score of 680 or higher for the typical applicant. However, you are not average once you paid your house off.

When the monthly payment on your housing debt becomes zero, two critical underwriting ratios help your cause tremendously! Top-notch performance on these two metrics could convince a home equity lender to approve credit scores well below the 680 guidelines.

  1. Loan-to-Value (LTV) includes the mortgage balance, which is now zero, making your application appear much safer
  2. Debt-to-Income (DTI) include the monthly mortgage payment, which is now zero, making your credentials stronger

Cash-Out Refinance

A cash-out refinance is also much simpler when you own your home outright because you do not have to borrow as much money. The new principal amount needs to satisfy one need rather than two.

  1. Zero needed to retire the existing mortgage balance
  2. Cash required to finance home improvement projects

A smaller principal amount helps people with poor credit qualify by keeping the two other critical underwriting ratios within acceptable bounds.

  1. LTV remains low when the refinanced principal is small
  2. DTI stays low with small refinanced amounts

HELOC

Likewise, getting a Home Equity Line of Credit (HELOC) should prove less demanding without a mortgage – even if you have a low score because of adverse payment history on your consumer report. Your low DTI and LTV ratios should help your application.

A HELOC is a revolving account that features a set borrowing limit, variable interest rates, and flexible repayment terms, much like a credit card. They work great as an emergency source of funding in the event of job loss, medical problems, or pandemics.

Their potential use in emergencies makes a HELOC riskier to banks. Therefore, expect the minimum credit score to be higher than with an installment contract.