Homeowners can use a home equity line of credit (HELOC) to tap into their home’s equity for a variety of uses. Because the line of credit is secured using your home as collateral, the effect of a HELOC on your credit score may be different than you think.
Here’s what you need to know:
The Credit Check
When applying for a HELOC, we will run a credit check by ordering a copy of your credit report from a credit bureau. This will generate what’s called a “hard inquiry” on your credit report. A hard inquiry impacts your credit, decreasing it by usually no more than five points.
Fortunately, the adjustment is temporary. A hard inquiry remains on your file for just two years, but only affects your credit score for one. Moreover, hard inquiries make up just 10% of your credit score, and multiple checks in a short period of time generally aren’t cumulative. In other words, don’t let the credit check discourage you from applying for a HELOC.
Impact on Credit Utilization Ratio
Your credit utilization ratio measures how much credit you have available against how much you have used. A higher ratio negatively affects your credit score. Having more available credit and not using much of it will help your score.
Although a HELOC is considered revolving credit, similar to a credit card, it won’t impact your credit score. This is because a HELOC is secured by your home and FICO® is designed to exclude the HELOC from your credit utilization ratio.
The Consequences of Not Repaying
Because your home is used as collateral for the HELOC, it’s important to know that the lender can foreclose on your home if you fail to pay back the line of credit, just as it can on a regular mortgage. That’s why using the funds from a HELOC thoughtfully is important.
And just like any other loan, a missed payment, even during the draw period, will hurt your credit score and remain on your report for up to seven years.
Using a HELOC for Debt Consolidation
Some homeowners use HELOCs to pay down other debt, particularly if that debt is at a higher interest rate. This is something to consider and could help with your budgeting goals and credit score.
By reducing the amount of debt you owe to credit cards, for example, you also reduce your credit utilization ratio, giving your credit score a boost. The little bit of interest you save in the short term might also improve your budget and reduce the temptation to use a credit card on future purchases.
The bottom line is that a HELOC won’t hurt your credit score much. It might even help it in the long run, provided you consistently make your payments on time. But a HELOC isn’t the only borrowing option available to homeowners. A home equity loan or a personal loan or line of credit may also be good options to help you meet your financial goals.
If you have questions about whether a home equity loan or line of credit are right for you, call us at (800) 649-0193, extension 4925. Our real estate specialists are here to assist you.
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Before you decide between a mortgage refinance and a home equity loan or line of credit, call us. Our real estate experts will help you determine the best option for you.