A home equity line of credit (HELOC) can be a valuable financial instrument. This is especially true for big-ticket projects such as home improvement projects or paying off debts. A HELOC can also come on a day when a cash flow is needed and has a facility that allows cash against the home.
However, utilizing this credit facility can also result in some undesirable consequences. Using a HELOC judiciously may help boost your score. The credit utilization ratio is the most crucial factor determining how HELOCs can be used without damaging one’s credit history.
What Is a HELOC and How Does It Work?
A Home Equity Line of Credit (HELOC) is a revolving credit line that uses your home as collateral. HELOCs allow you to borrow up to a specific limit, and you only pay interest on the amount you borrow. As you pay down your balance, the credit becomes available to borrow again.
HELOCs usually have variable interest rates, which adjust based on the prime rate. The rates are often lower than those of other loans, and the interest may be tax-deductible. After a draw period, typically 10 years, you enter the repayment phase, paying back the borrowed amount with interest.
Does Applying for a HELOC Impact Your Credit Score?
Yes, applying for a HELOC can temporarily affect your credit score. This happens because the lender performs a hard credit inquiry when you apply. A hard inquiry can lower your credit score by a few points, but the effect is usually temporary and fades within two years.
If you make multiple applications quickly, each inquiry could further reduce your score. However, your credit score can improve over time if you manage your HELOC responsibly by making on-time payments and using it to pay off high-interest debt.
How Using a HELOC Can Affect Your Credit Utilization?
Your credit utilization ratio refers to how much credit you use compared to how much is available. A high credit utilization ratio can negatively impact your credit score. However, FICO® credit scoring often excludes HELOCs from your credit utilization calculations because HELOCs are secured by your home, unlike credit cards.
This means borrowing from a HELOC won’t necessarily raise your credit utilization ratio, which can impact your score. Still, it’s essential to manage any outstanding balances carefully.
Read related blogs: What Credit Score Is Needed to Buy a House? Improve Now
Repaying a HELOC and Its Influence on Credit Score
Repaying your HELOC on time can positively influence your credit score. This is because payment history is a significant factor in credit scoring. Consistently making on-time payments helps build a strong credit history.
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Additionally, having a HELOC can improve your credit mix, another factor that credit scoring models consider. A diverse credit profile, which includes installment loans like a HELOC, can positively impact your overall score.
What to Consider Before Taking a HELOC to Protect Your Credit?
Before taking out a HELOC, it’s essential to understand all the costs involved. Some HELOCs have annual maintenance fees or other charges, even if you aren’t actively using the credit line. If you sell your home, you will typically need to pay off the HELOC in full immediately, which could affect your financial planning.
Conclusion
To wrap it up, the HELOC can be both a blessing and a curse in your credit score affairs. Even if most people talk about how applying for such a credit facility is terrible because it will entrench a hard inquiry in your credit profile, this is very short-term. Learning about the risks and benefits associated with HELOCs is essential.
For those seeking flexible alternatives to an HELOC, loan options from the Beem app can be a great option for addressing urgent financial needs. Beem offers quick access to funds without tapping into your home equity, providing a more straightforward way to manage short-term financial gaps.
People Also Ask
Does a HELOC count as debt on your credit report?
Yes, a HELOC counts as debt on your credit report since it is a line of credit secured by your home.
Can a HELOC lower your credit score?
Yes, applying for a HELOC can temporarily lower your credit score due to the hard inquiry, but responsible usage can improve your score over time.
How much does a HELOC affect credit utilization?
FICO® typically excludes HELOCs from revolving credit utilization, meaning it may not directly impact your credit utilization ratio. However, it’s still important to manage the debt responsibly.