Does a Heloc Affect Your Credit Score?

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A Home Equity Line of Credit (HELOC) can be a credit nightmare or a credit dream, depending on how you use it.

Tapping into a home’s equity to fund expenses such as debt consolidation, home renovations and education is now more accessible. Over the past year, the average amount of owner’s equity has grown to over $ 200,000, according to the Homeowner Equity Insights report from housing data firm CoreLogic.

This loan product uses the value of your home to secure a line of credit that can be repaid over a period of several years. It is a risky decision if you do not pay off the debt since your house could be foreclosed by the bank. However, a HELOC can be a great loan option if you are in good financial health and think you could make the monthly payments.

Obtaining a HELOC can be a good, albeit risky, way to use the wealth in your home. If used responsibly, a HELOC can actually help boost your score. And as with any debt or loan, if abused, a HELOC will negatively affect a credit score.

Here are the implications of a HELOC’s credit score and what you will need to consider before moving forward.

What is a HELOC?

“A HELOC is a revolving line of credit in which a borrower uses the equity in their home to acquire funds that will be repaid over the life of the loan, similar to a second mortgage,” explains Nicole Christopherson, real estate broker. . at NMC Realty, based in California.

“What differentiates HELOCs is that the borrower did not advance the entire amount in advance; it acts more like a credit card, ”explains Christopherson. Borrowers use a line of credit, typically capped at 60% to 70% of a home’s value, to borrow funds during the “drawdown period”. Repayment periods can be up to 20 years, and the borrower then repays the balance owed in monthly installments plus interest.

HELOCs are similar to credit cards where lenders can offer different interest rates, credit limits and minimum payments, according to Ryan Cicchelli, founder of Generations Insurance & Financial Services, a healthcare and retirement planning company in Michigan. Typically, HELOCs carry lower interest rates than credit cards and may be easier to obtain for people with lower credit scores, Cicchelli adds.

How a HELOC can damage a credit score

“If you’re someone with less strength when it comes to financial responsibility or trying to get a HELOC at a tumultuous time in your life, you could face serious repercussions if you approve of it,” Cicchelli explains. This is why it is important to examine your credit behavior before taking a HELOC.

Here’s what to consider:

Credit check: Anytime a lender checks your credit this is called a serious credit check, it can lower your score slightly. These points stay on your credit report for up to two years. Applying for HELOC counts as a firm credit application and gives similar results.

Variable payments: HELOC payments may fluctuate due to its variable interest rate. This can make budgeting difficult if payments become unmanageable. Since on-time payment history is 35% of a credit score, any missed HELOC payment is detrimental.

Use of credit: Just because you can borrow a certain amount doesn’t mean you should. Using all of your available credit with a HELOC is considered high risk behavior for credit reports. “If you have a $ 100,000 line of credit and you take it out all of a sudden, ‘it’s treated like a line of credit at most,” says Mayer Dallal, managing director of Mortgage Bank of California.

Surpass oneself: If you borrow too much from your available line of credit, it leaves no room in your borrowing budget for unforeseen emergencies such as car repairs or medical bills. It is recommended that you set up an emergency savings fund before borrowing through a HELOC. But, if you don’t have emergency funds and you need a HELOC to fund an emergency, leave room in your line of credit for other emergencies. If you run out of HELOC financing and a financial emergency arises, you risk missing payments, which is the main factor in a credit score.

Closing a HELOC: Closing any line of credit can negatively affect your credit score. The effect may be greater if your HELOC is one of the few lines of credit you have.

How a HELOC Can Improve Your Credit Score

“As long as you don’t lie down too much, have too many open lines of credit with high balances, make payments on time, and manage your HELOC as well as you should manage any other debt, you will see positive results on your credit report. “Says Cicchelli.“ Wobble in any of the areas mentioned above, and you will see the repercussions. ”Here’s how to use a HELOC as an opportunity to improve your credit score.

Use of credit: By using HELOC funds to pay off any debt, you can lower your credit utilization rate and increase your credit score, according to Christopherson.

If you know how much debt you have and how much you can comfortably take on, it may be worth it, Cicchelli explains.

Use of credit: However, as you pay off your HELOC balance, your credit usage – which is 30% of your score – will decrease over time and improve your score.

Payments on time: By paying your HELOC on time and in full each month, this behavior is reflected well on credit reports and can only improve or maintain your credit score.

How to prepare your credit for HELOC

Solve other debts: Too many open credit accounts can lower your credit score. It is a good idea to pay off other debts before taking out a HELOC. This will help compensate for going over your total line of credit, negatively affect your credit utilization rate, and ultimately your credit score.

Existing own funds: One of the most important factors in getting a HELOC, according to Christopherson, is already having 15-30% of the equity in your home. “This is one of the most important factors in how much you can ultimately borrow, which is typically 85% of your combined loan-to-value ratio,” she says.

Decrease DTI: Your Debt-to-Income Ratio (DTI) is an indicator of how much debt you can take on and is a number most lenders look outside of your credit score. Most lenders prefer a DTI of less than 43%. If more than 43% of your income is spent on debt owed, you’ll want to work on reducing that amount first before taking out another loan like a HELOC.

Improve Your Credit Score: The ideal credit score for getting the best HELOC interest rate is 720+. To improve your overall credit score:

  • Make payments on time on all your accounts.
  • Keep old credit accounts open.
  • Have a healthy mix of installment, revolving, and open credit.
  • Monitor how often you open new credit accounts.
  • Sound Management of Credit Use – Your Percentage of Total Debt.

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