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The equity in your home can be a useful resource when you need a large sum to make home improvements, pay off debt or for other big expenses. And a key tool for tapping this source is a home equity line of credit (HELOC).
When it comes to your credit score, your HELOC has a lot in common with a credit card. It can have a small impact on your credit score when you apply for one, but a larger one if payments are late or missed. As additional debt, it can ding it — but can also boost it as an enhancement of your total available credit. Basically, a HELOC’s impact on your credit score usually comes down to how you manage the account.
- Having a HELOC by itself doesn't affect your credit score, but how you manage it does
- HELOC applications require a hard credit pull, which does temporarily lower your credit score
- The HELOC's debt balance could lower your credit score
- Using HELOC funds to pay off other, higher-interest debt can improve your credit score
How applying for a HELOC affects your credit
When you apply for a HELOC, the lender will check your credit score., This “hard pull” or “hard check” has the potential to temporarily lower the score. However, if you haven’t applied for other credit recently, the impact will be minimal, says Jackie Boies, senior director, Partner Relations at Money Management International, a Texas-based nonprofit debt counseling organization.
“The inquiry will remain on your credit report for two years, but generally only impacts your credit score for about six months,” says Boies.
“Overall, a single inquiry for credit will have minimal impact, typically five to 10 points,” says Suzanne Mink, assistant vice president of Consumer Lending at Connex Credit Union.
How using a HELOC affects your credit
“A HELOC is an open line of credit and subject to being used in the same manner [as a credit card],” says Boies. “As with all debt, it will be very important to maintain timely payments and develop an excellent payment history on your HELOC.”
Like a credit card, with a home equity line of credit, you can borrow money against your credit when you need to and make only minimum payments during the draw period. “That’s why a HELOC is listed as a revolving account like your other credit card accounts,” says Mink. “The credit report will show the HELOC balance, credit line and payment history.”
Unlike a credit card, however, the outstanding balance of the HELOC is not considered when you’re seeking another loan; it won’t affect the calculation of your credit score.
What happens to your credit score if you don’t tap the HELOC very often?
One factor in determining your credit score is how much of your total available credit — across all your cards and credit lines — you’ve used, known as credit utilization ratio. The lower the ratio, expressed as a percentage, the better your score. Your credit score can increase if much of the HELOC goes untapped, because you have a lot of available funds you’re not using.
How a HELOC can improve your credit score
A HELOC can improve your credit score in several ways.
First of all, you can boost your credit score by making timely payments toward your HELOC. If you make your HELOC repayments reliably, you may actually build your credit by establishing a history of on-time payments. If you don’t have a lot of credit accounts, a HELOC will also help establish your credit history and give other lenders more confidence.
Plus, debt related to homeownership tends to be seen as “good debt” by credit agencies. Because your HELOC is tied to an asset that could increase your net worth, borrowing against your home is often better than taking out a credit card or personal loan as far as your credit score is concerned.
Using a HELOC sparingly can also improve your score, by lowering your credit utilization ratio. Lenders will see that you have access to ample funds, but the discipline not to bump up against your limits.
Using your HELOC to get pay off other loans or balances (especially on credit cards) may also result in a score increase — if the net amount of debt you’re carrying decreases overall.
How closing a HELOC affects your credit
Closing a HELOC can impact your credit score, especially if you don’t have much credit available elsewhere. “Closing a HELOC will reduce one’s available credit and could have a negative impact if the percentage of revolving balances breaches a certain percentage,” says Matt Hackett, operations manager of Equity Now, a New York-based direct mortgage lender.
For instance, if you have a HELOC for $10,000 and close the account after it is paid off, that means the $10,000 of available credit is no longer being factored into your credit score.
The impact to a credit score will be greater if the person has a short credit history, is relatively new to credit or has few credit cards. “Credit history makes up about 15 percent of your score,” says Mink. “A longer credit history will help to improve your score.”
Each month you keep the HELOC open extends your credit history.
Don’t let a HELOC negatively impact your credit score
Drawing on your HELOC could drop your credit score, as the addition of any new debt to your record would. But FICO doesn’t consider your HELOC utilization when it’s calculating your score, so you’re not penalized for using all of the available credit in your HELOC (unlike with a credit card, where it’s recommended to not to use more than about 30 percent of your limit).
There are some ways to mitigate any potential damage to your credit when you open a HELOC:
- Resolve other debts. Several open credit accounts can negatively impact your credit utilization ratio, which will ultimately bring down your credit score. Try to pay down other debt before taking out a HELOC.
- Shop rates and get quotes from different lenders within a 45-day window. FICO considers similar inquiries that have occurred within 45 days of each other as a single inquiry. This time period might vary depending on the credit scoring model used, but it’s typically between 14 and 45 days.
- Make timely HELOC payments. A missed payment on your HELOC is likely to cause your credit score to drop. Depending on your lender, there might be a grace period before it’s reported to the credit bureaus.
Bottom line on HELOCs and credit scores
It’s best to use a HELOC for specific needs, such as paying off high-interest credit cards or repairing your home, says Boies. Using equity to increase the value of your home is smart, especially since the interest you pay on your HELOC might be tax-deductible if you use the funds to substantially improve your home. Since HELOCs tend to have lower interest rates than credit cards or personal loans, they could make the most financial sense.
Additional reporting by Lara Vukelich