Yes, Home Equity Lines of Credit (HELOCs) can have an impact on your credit score. Whether this impact on your credit score is negative or positive depends on how you manage your HELOC. It also depends on your overall financial situation and your ability to make timely payments on any amount you borrow through your home equity line of credit. Learn 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 are approved for a HELOC depends on your credit history. However, a HELOC is not a second mortgage.
Unlike a mortgage, you can withdraw money from your HELOC as needed, using only the amount you need, and paying off your loan on a revolving basis or in monthly installments. It works much like a credit card, but with a larger available credit limit. For example, if you have $ 40,000 in equity and you are approved for a HELOC for the full amount, you can withdraw up to that amount in funds.
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You could withdraw $ 10,000 to put the siding on your house and start repaying that amount according to your loan agreement. Later, you may want to cover some of your child’s tuition costs by using an additional $ 5,000 from HELOC. You continually repay what you borrow on the equity line, unless you have paid off the entire balance.
It is important to note that a HELOC is a loan that is extended based on the value of your home. This means that if you don’t pay off your home equity line of credit (you take the money out and never make the required payments), you could potentially face a foreclosure situation.
How is a HELOC different from a home equity loan?
HELOCs and home equity loans share some similarities. In either case, you will take out a loan against the equity in your home. But while your home equity loan will give you the money all at once, a HELOC gives you a fixed amount of money, depending on your needs, that you can borrow and pay back.
Home equity loans are similar to any other loan: an equity loan that you take out will have a fixed interest rate, a lump sum, etc. On the other hand, home equity lines of credit have an interest rate, but they are usually lower and only apply to the amount of money you withdraw.
Is a Home Equity Line of Credit a Good Idea?
Whether or not this is a type of credit is a good idea depends on your personal financial situation. If you are drowning in debt and using the equity in your home to pay the bills, you are simply trading one type of financial problem for another. But if you’re using your HELOC to pay off high interest credit card debt so that you only have one low interest debt to worry about, it might be a smart move.
Only you can decide if a home equity line of credit is right for you. However, if you have a bad credit rating or other negative factors, you may not be 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 repairing your credit before applying for a home equity loan.
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 are extending your available credit. If you open the line and don’t use any credit, your credit utilization rate will improve, which could also improve your credit score. And if you make timely payments on the credit you borrow against that equity line, these are positive things that can be pointed out on your credit history.
See: Here’s What Borrowers Really Think About Home Equity Lines of Credit
On the other hand, if you take a large chunk of your equity margin, you have a higher credit utilization rate, which can hurt your score. Not making timely payments could potentially lower your score as well. Since HELOC rates can be variable, you should allow for fluctuating payment requirements to avoid this problem.
Are unused lines of credit bad for your credit score?
Unused lines of credit usually 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 view you as a potential risk, especially if you don’t have the income to support that credit. This is because you could suddenly withdraw a large amount from that equity line with no income to pay it off, putting your other debts at risk as well.
What are the advantages of a HELOC?
As with 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 to manage that credit. You can use it as needed, giving you more control over what kind of payments you need to make at any given time.
What are the disadvantages of a home equity line of credit?
The biggest downside to a HELOC is that it’s tied to your home, which means there’s a slight risk of foreclosure or mortgage lien if you don’t make your payments. Payments can also run on variable interest, which means it’s not always the most affordable credit option for homeowners.
Read more: Everything You Need to Know to Get a Home Equity Line of Credit
It may also look like a large credit card account on your report, so if you only need a small amount of short-term credit, you may want to consider personal loan options instead.