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 does a HELOC work?
HELOCs are revolving credit lines that are secured by the equity in your home. A few reasons homeowners take out HELOCs are to use the cash to make home renovations, cover unexpected expenses or pay down high-interest debt such as credit cards. The big advantage of HELOCs is that they have much lower interest rates than plastic. As of January 14, 2022, the average rate on a HELOC was 6.24 percent.
These loans operate in a similar way to credit cards. During an initial draw period that usually lasts 10 years, you’re allowed to borrow money from the HELOC when you need to, carry a balance from month to month and make minimum payments. During that period, you’ll typically only be required to make interest payments. After the first 10 years, you’ll enter the repayment period, which often lasts 20 years. During that time, you’ll need to pay both the interest and principal amount, and you won’t be able to make any draws. Making a late payment or missing a payment can both lower your credit score and put you at risk of having the lender foreclose on the home.
Does a HELOC affect your credit score?
A HELOC may impact your credit score in a variety of ways, from application through repayment. However, some of these effects could be temporary.
How applying for a HELOC affects your credit
When you apply for a HELOC, potential lenders will check your credit score, which has the potential to temporarily lower your credit score. However, if you haven’t applied for other credit recently, the impact will be minimal, says Jackie Boies, a senior director of housing and bankruptcy services for 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,” Boies says.
“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, Mink says.
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),” Boies says. “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, a HELOC is a revolving line of credit, so 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,” Mink says. “The credit report will show the HELOC balance, credit line and payment history.” But 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, which is known as credit utilization. Your credit score can increase if the HELOC is untapped and there is a large amount of available credit, says Leo Loomie, a senior vice president of client development at Digital Risk, a New York-based provider of digital technology platforms and services. “Not drawing on an open line is very similar to having a credit card open and not using it.”
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 a homeowner has a HELOC of $10,000 and closes the account after it is paid off, that means the $10,000 of available credit is no longer being factored into the homeowner’s 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,” Mink says. “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 may 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 may 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 may be a grace period before it’s reported to the credit bureaus.
The bottom line
It’s best to use a HELOC for specific needs, such as paying off high-interest credit cards or repairing your home, Boies says. Using equity to increase the value of your home is smart, especially since the interest you pay on your HELOC will be tax deductible if you use the funds to substantially improve your home. And since HELOCs tend to have lower interest rates than credit cards or personal loans, they may make the most financial sense.
Before applying for a HELOC, make sure you’re prepared for the potential impacts to your credit score by taking the following steps:
- Raise your credit score before applying: Taking steps to improve your credit score will lessen any impacts from hard credit inquiries and help you get the lowest rates.
- Shop around: Comparing HELOC rates from a few lenders, especially if you can get prequalified without a hard credit check, is the best way to find the cheapest loan.
- Understand how the HELOC draw period works: Make a financial plan for your HELOC’s draw period and repayment period to avoid hurting your credit by missing payments.