When it comes to your credit score, your home equity line of credit has a lot in common with a credit card. Here’s what you need to know about how your HELOC can help or harm your credit.
A HELOC, or a home equity line of credit, can have a small impact on your credit score when you apply for one, but a larger one if payments are late or missed.
HELOCs are revolving credit lines that are secured by the equity in your home. One reason homeowners take out a HELOC is to use the cash for home renovations, cover unexpected expenses or pay down high-interest debt such as credit cards. The big advantage of a HELOC is they have much lower interest rates than plastic. In early August, the average rate on a HELOC was 7.27 percent, compared with 17.82 percent for credit cards, according to Bankrate.
These loans operate similar to credit cards. During the initial 10-year draw period 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, typically only interest payments are required. After the first 10 years, you’ll need to pay both the interest and principal amount for the remaining 20 years. 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 applying for a HELOC hurt my credit score?
When you apply for a HELOC, potential lenders will check your credit score. If you haven’t applied for other credit recently, the impact will be minimal, said Jackie Boies, a senior director of housing and bankruptcy services for Money Management International, a Sugar Land, 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 said.
Before you start applying for a HELOC, it’s a good idea to check your credit report to ensure there aren’t any mistakes, says Suzanne Mink, assistant vice president of consumer lending at Connex Credit Union, a North Haven, Connecticut-based credit union. Errors in your report could result in a lower score, which can hurt your chances of being approved for a HELOC. You can receive a free credit report from all three bureaus at www.annualcreditreport.com.
While seeking more credit can signal greater risk to a lender, multiple inquiries from auto, mortgage or student loan lenders within a short period of time doesn’t have a large impact on a credit score.
“Overall, a single inquiry for credit will have minimal impact, typically five to 10 points,” Mink said.
Before you apply to multiple lenders, do your research first because 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 said. Research each HELOC lender to see if the financial institution charges additional fees and costs.
Obtaining a HELOC impacts your credit score
Once you’re approved for a HELOC, however, the loan backed by your home will be reported like other revolving credit such as a credit card instead of a second mortgage, Boies said.
“A HELOC is an open line of credit and subject to being used in the same manner (as a credit card),” Boies said. “As with all debt, it will be very important to maintain timely payments and develop an excellent payment history on your HELOC.”
Since a HELOC is a revolving line of credit, you can take money from the loan when you need to, such as repairing the roof or remodeling a bathroom.
Similar to a credit card, you can make just the minimum payments.
“That’s why a HELOC is listed as a revolving account like your other credit card accounts,” Mink said. “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, she says.
What happens to your credit score if you don’t tap the HELOC very often
Homeowners who don’t draw down on the available credit in the HELOC won’t see a change to their credit score.
The scoring models that determine a credit score don’t consider the credit utilization ratio in the same way as credit cards, Mink said. (The credit utilization ratio is how much you charge on the HELOC vs. how much credit is available to you.)
“Whether you use the HELOC or not would have a minimal impact on your credit score,” Mink said.
You can, however, boost your credit score by making timely payments toward your HELOC.
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, said 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,” Loomie said.
How closing a HELOC impacts credit scores
Closing a HELOC can impact your credit score, especially if you’ve used the available credit from credit cards or other loans.
“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.
A person’s credit utilization will be impacted when the account is closed. If a homeowner had 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 credit score, Boies said.
“If you have other revolving credit, then closing it may not be as impactful,” Boies said. “Additionally, your credit score calculation considers the length of your credit history and every month the HELOC is open you are extending that history.”
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 said. “A longer credit history will help to improve your score. Don’t close your HELOC unless it’s necessary.”
Only use a HELOC for specific needs, such as paying off high-interest credit cards or repairing your home, Boies said.
“You are tapping into the equity on your home, which is likely your largest asset,” Boies said. “Using the equity in your home is most advantageous when you are making improvements that will increase the value of your home.”
Keep in mind that recent federal tax law changes mean that interest on home equity is only deductible if the proceeds are used to buy, build or substantially improve your home.
Since HELOCs have a lower interest rate than the majority of credit cards and typically a much higher level of credit available, they can be great tools for responsible borrowers, Loomie says.
“People can access a large source of funds for home improvements and debt consolidation of loans with much higher rates such as personal loans and credit cards, leveraging equity they already have and saving a significant amount of money on interest,” Loomie said.