Yes, home equity lines of credit (HELOC) can have an impact on your credit score. Whether that impact to your credit score is negative or positive depends on how you manage your HELOC. It also depends on your overall financial situation and ability to make timely payments on any amount you borrow via your home equity line of credit. Find out more about how a HELOC affects a credit score.
What Is a HELOC?
HELOC stands for home equity line of credit. If you have equity in your home, you can use it to take out a line of credit up to that value. Whether or not you’re approved for a HELOC depends on your credit history. However, a HELOC is not a second mortgage.
Unlike a mortgage, you can take out money from your HELOC as you need it—using only the amount you need—and paying your loan back in a revolving manner or in monthly payments. It works a lot like a credit card but with a larger available credit limit. For example, if you have $40,000 in equity and get approved for a HELOC for the total amount, you can take out up to that much in funds.
You might take out $10,000 to put siding on your house and begin paying back that amount according to your lending agreement. Later, you might want to cover some of your child’s college tuition, using another $5,000 of the HELOC. You continuously payback what you borrowed on the equity line unless you have paid back all of the balance.
It’s important to note that a HELOC is credit that is extended based on your home’s value. That means if you default on your home equity line of credit—you take out money and never make the required payments—you could eventually be dealing with a foreclosure situation.
How is a HELOC Different from a Home Equity Loan?
HELOCs and home equity loans do share some similarities. In both cases, you’ll be taking out a loan from your home equity. But while your home equity loan will give you the money all at once, a HELOC gives you a set amount of money, as you need it, that you can borrow and payback.
Home equity loans are similar to any other loan—an equity loan you take out will have a fixed interest rate, lump sum, etc. On the other hand, home equity lines of credit do have an interest rate, but they’re typically lower and only applied to the amount of money you take out.
Is a Home Equity Line of Credit a Good Idea?
Whether or not any type of credit is a good idea depends on your personal financial situation. If you’re drowning in debt and using your home equity to pay the bills, you’re just swapping one type of financial issue for another. But if you’re using your HELOC to payoff high-interest credit card debt so you only have a single, lower-interest debt to worry about, this might be a smart move.
Only you can decide if a home equity line of credit is a good idea for you. However, if you have a poor credit score or other negative factors, you may not get approved for a HELOC. Or, the HELOC may come with unfavorable terms that make it too expensive to use as a form of credit. You may want to work on fixing your credit before applying for home equity lending.
How Does a HELOC Affect a Credit Score?
Any type of credit you use can impact your credit score. When you take out a HELOC, you extend how much available credit you have. If you open the line and don’t use any of the credit, your credit utilization rate will be improved, which could also potentially improve your credit score. And if you make timely payments on credit you borrow from this equity line, those are positives that can be reported on your credit history.
On the other hand, if you take out a large portion of your equity line, you have a higher credit utilization rate, which can hurt your score. Failing to make timely payments could also potentially drop your score. Since HELOC rates can be variable, you must plan for fluctuating payment requirements to avoid this issue.
Do Unused Credit Lines Hurt Your Credit Score?
Unused lines of credit typically improve your utilization rate, which would improve your credit score. However, HELOCs are a type of revolving credit, just like a credit card.
If you have a huge amount of unused credit, some lenders might see you as a potential risk—especially if you don’t have the income to back up this credit. This is because you could suddenly take out a large amount on this equity line without the income to pay it back, putting your other debts at risk too.
What Are the Benefits of a HELOC?
Just like any other loan, there are pros and cons to taking out a HELOC. The benefits of a home equity line of credit include the ability to get a large amount of credit based on your home’s value and flexible options for managing that credit. You can use it as you need it, which gives you more control over what type of payments you need to make at any given time.
What Are the Disadvantages of a Home Equity Line of Credit?
The biggest disadvantage of a HELOC is that it’s tied to your home, which means there’s a slight risk of foreclosure or a home lien if you don’t make your payments. The payments may also work on a variable interest, which means this isn’t always the most affordable credit option for homeowners.
It can also look like a large credit card account on your report, so if you only need a small amount of credit on a short-term basis, you might want to consider personal loan options instead.