The equity in your home can be a useful tool when you need a large sum to make home improvements, pay off debt or for other big expenses. A home equity line of credit (HELOC) can be an attractive option to tap this equity.
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. However, timely payments on your HELOC can also boost your credit score. A HELOC’s impact on your credit score usually comes down to how you manage the account.
How applying for a HELOC affects your credit
When you apply for a HELOC, the lender will check your credit score, which has the potential to temporarily lower it. 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.
Multiple inquiries from auto, mortgage or student loan lenders within a short time period don’t have a large impact on a credit score. However, if you decide to compare interest rates and fees over a longer period of time, several hard inquiries could be harmful to your credit score, says Mink.
How using a HELOC affects your credit
Once you’re approved for a HELOC, the loan backed by your home will be reported like other revolving credit, such as a credit card, instead of like a second mortgage.
“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 HELOC, you can take money from the loan 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, the amount of the available credit used from the HELOC is not considered when determining your credit score when you’re seeking another loan.
You can, however, boost your credit score by making timely payments toward your HELOC.
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 you’ve used, known as credit utilization. Your credit score can increase if the HELOC goes untapped and there is a large amount of available credit.
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.
What to do to minimize any negative effects on your credit
Some actions could help minimize any negative effects on your credit when you take out 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.
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.