How Does A HELOC Affect Your Credit Score?

When you need a large sum of cash  — to make home improvements, pay off debt or for other big expenses — a key source can be the equity you’ve built up in your home, accessed through a home equity line of credit (HELOC). But before applying for one, you might wonder: Does a HELOC affect your credit score? After all, most loans and debts do.

A HELOC’s impact on your credit score usually comes down to two things: how your lender reports it to the credit bureau and how you manage the account. “It all depends on how you use it. If you keep your balance low and make your payments on time, it can help your credit score,” Linda Bell, senior writer on Bankrate’s Home Lending team, explains. “If you keep your balance low and make your payments on time, it can help your credit score. But if you max out the amount you can draw out or miss payments, it can have a negative effect.”

How applying for a HELOC affects your credit

When you apply for a HELOC, the lender will check your credit score. This “hard pull” or “hard check” has the potential to temporarily lower that three-digit number. “The inquiry will remain on your credit report for two years, but generally only impacts your credit score for about six months,” says Jackie Boies, senior director, Housing Services at Money Management International, a Texas-based nonprofit debt counseling organization.

If you haven’t applied for another loan or a credit card recently, the difference in your score should be small. “Overall, a single inquiry for credit will have minimal impact, typically five to 10 points,” says Suzanne Mink, retired vice president of consumer lending at Connex Credit Union.

How using a HELOC affects your credit

Does a HELOC affect your credit score after you open it? Yes, it can, both positively and negatively.

The HELOC can be reported to credit bureaus in one of two ways: as an installment loan (i.e., a second mortgage) or as a “revolving account like your other credit card accounts,” says Mink (reflecting the fact that you can borrow money against your credit limit and either repay the funds in full or make only minimum payments, the same as you can on the plastic). If it’s reported as the latter, the amount you withdraw could affect your credit utilization ratio (see below). However it’s reported, your HELOC balance will show up under overall “amounts owed” on your credit report, which lenders and creditors use to determine your total amount of debt. A large amount of debt can ding your credit score.

Credit history/credit mix

While amount of money owed makes up the biggest piece of your FICO credit score (30 percent), the calculation looks at other factors, too. So, how does a HELOC affect your credit score in those other areas? Let’s look at two of note:

• Length of credit history (15 percent): Financial institutions want to know that you have a proven track record of managing your money well. If you’ve had credit available to you for a long period of time and you’ve done a good job with it, that helps your credit score. Time is on your side here. Opening a new line of credit reduces the average age of your accounts, which can hurt your credit score. 
• Credit mix (10 percent): A strong borrower manages a mix of credit types well. Having a variety helps your score. You might want to find out how the lender plans to report your HELOC so you can plan accordingly. Since you already have an installment loan in the form of a mortgage, it’s generally better if they report it as a revolving credit account. That said, if you’ve got a lot of credit cards, it might help your mix more to have the HELOC reported as an installment loan.

What if you don’t tap the HELOC very often?

One factor in determining your credit score is how much of your total available credit — across all your cards and credit lines — you’ve used, known as credit utilization ratio. The lower the ratio, expressed as a percentage, the better your score.

However, HELOCs are an exception. Because they are secured debt (using your home as collateral), FICO doesn’t consider your HELOC utilization when it’s calculating your score, though other measures, like Vantage Scores, might. So you don’t get points for not tapping the HELOC balance, and you’re not penalized for maxing it out. In contrast, with a credit card, it’s recommended to not use more than one-third of your limit.

How a HELOC can improve your credit score

If you make your HELOC repayments reliably, you can build your credit by establishing a history of on-time payments. If you don’t have a lot of credit accounts, a HELOC will also help establish your credit history and give other lenders more confidence in your ability to repay what you borrow.

Plus, debt related to homeownership tends to be seen as “good debt” by credit agencies. Because your HELOC is tied to an asset that could increase your net worth, borrowing against your home is often better than taking out a credit card or personal loan as far as your credit score is concerned.

Using a HELOC to pay off credit card balances can also improve your score, by lowering your credit utilization ratio. Ideally, you want to keep this ratio below 30 percent. Your HELOC can help here because FICO specifically excludes HELOCs when calculating credit utilization ratios, remember — whereas credit cards definitely do count towards them.

Let’s say you had a credit card with a $10,000 limit and you currently have a balance of $7,000 on it. If you pay off that balance with your HELOC, you’ll move that debt out of your credit utilization ratio. And since this ratio accounts for one-third of your credit score, this can help you give your score a notable bump.

How closing a HELOC affects your credit

While the size of your HELOC balance may not affect your credit score all that much, the presence of the balance itself does.

So, closing a HELOC can impact your credit score. It can hurt your credit mix if it was one of your only installment loans or revolving credit accounts (depending on how your lender was reporting it). 

The impact to a credit score will be greater if the person has a short or new credit history or has few credit cards. “Credit history makes up about 15 percent of your score,” says Mink. “A longer credit history will help to improve your score.” Each month you keep the HELOC open extends that history.

How to safeguard your credit score when opening a HELOC

Establishing your HELOC could initially lower your credit score, as the addition of any new debt to your record would. And missing HELOC payments will definitely ding your score.

However, here are some ways to mitigate any potential damage to your credit when you open a HELOC:

• Resolve other debts. Several open credit accounts with high balances can negatively impact your credit utilization ratio, which will ultimately bring down your credit score. Try to pay down other debt before taking out a HELOC.
• Shop rates and get quotes from different lenders within a window. FICO considers similar inquiries that have occurred within within a month or so of each other as a single inquiry. This time period might vary depending on the credit scoring model used, but it’s typically between 14 and 45 days.
• Make timely HELOC payments. A missed payment on your HELOC is likely to cause your credit score to drop. So would a payment for less than the minimum. Depending on your lender, there might be a grace period before it’s reported to the credit bureaus. The reverse is also true. You can boost your credit score by making timely payments toward your HELOC.

“When using a HELOC, planning is key,” Bell advises. “Start by figuring out exactly what you need and set a budget to avoid overspending. Only borrow what you can comfortably repay, keeping in mind that interest rates can change. By managing your HELOC wisely, you can prevent any negative impact on your credit score.”

Final word on HELOCs affecting credit scores

Your HELOC has a lot in common with a credit card. It can have a small impact on your credit score when you apply for one, but a larger one if payments are late or missed. It also impacts your credit mix and length of credit history, which in turn can impact your score.

It’s best to use a HELOC for specific needs, such as paying off high-interest credit cards or repairing your home, says Boies. Using equity to increase the value of your home is smart, especially since the interest you pay on your HELOC might be tax-deductible if you use the funds to substantially improve your home. Since HELOC rates tend to be lower than those of credit cards or personal loans, they can be a good device to consolidate debt.

“As with all debt, it will be very important to maintain timely payments and develop an excellent payment history on your HELOC,” says Boies. Ultimately, your HELOC might help you show lenders that you have access to ample funds, but the discipline not to bump up against your limits — the very definition of a creditworthy client.

FAQ about HELOCs

• Does having a HELOC affect my mortgage?
  

  Having the HELOC might make it tougher to refinance your mortgage. Lenders consider all your obligations when evaluating you. They also expect you to have, and be able to maintain, a certain amount of equity in the home. Other than that, the HELOC is totally separate from your primary mortgage, and shouldn’t affect it. Actually, it’s more the other way around: Having a large mortgage can affect how big a home equity line of credit you can establish.

   

• Is a HELOC considered good debt or bad debt?
  

  That depends on how you use it. If you leverage it to improve your home or start a business, for example, it’s good debt that propels you forward, enhancing assets and your net worth. But if you use a HELOC to pay for discretionary items or everyday needs, because you can’t afford them otherwise, it’s bad debt.

   

• Is there a downside to having a HELOC?
  

  HELOCs can be dangerous if you don’t manage them carefully. Because they usually come with variable interest rates, your monthly payments can fluctuate. And those payments will jump dramatically if you only repay interest during the initial draw period, leaving the entire debt to handle during the repayment period. Given that your house is on the line if you default, it’s key to ensure you never borrow more than you can comfortably repay — even if interest rates climb — and— and to delay repaying the principal, even if the lender allows interest-only payments during the draw period.