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A home equity line of credit, or HELOC, allows a homeowner to borrow money from their home equity to cover major needs such as home improvements or medical bills, or to consolidate debt. HELOCs, like any other financial product, can have an influence on your credit score based on how you manage them.

A HELOC is a revolving line of credit with a variable interest rate, much like a credit card. The borrower can then draw on the line of credit as needed. Your home serves as security for a HELOC, therefore if you do not make your HELOC payments on time, you may lose your home.

Learn more about HELOCs and how they can improve or affect your credit score in this article.

A HELOC is an acronym for a home equity line of credit, and taking one out to access funds may have a direct impact on your credit score. Furthermore, taking up a HELOC requires a lender to conduct a hard investigation, which may temporarily lower your credit score by a few points.

There are numerous elements that might have a direct impact on your credit score, ranging from payment history to credit mix (the various types of accounts you own). Some items, such as HELOCs, may be more difficult to explain in terms of credit scores, but they can still have an impact depending on how you handle your account.

What is a HELOC?

A home equity line of credit (HELOC) is a line of revolving credit where you borrow against the value of your home.

For example, let’s say you are looking to pay off a large balance, such as medical bills, but you don’t have cash on hand to pay for it now. When you’re in a pinch, you may be able to borrow against your home’s equity — the difference between your home’s current market value and what you still owe towards your mortgage. This difference can become accessible to you as a line of credit. Lenders will let you borrow up to a certain percentage of this amount–around 60-85%, depending on factors such as your credit score and debt-to-income ratio.

Like many other forms of credit, HELOCs come with interest rates. These can either be fixed (the same flat rate for the life of the loan) or variable (the percentage changes due to market fluctuations) which affects how much you owe back in interest.

This is where having a good credit score can help you earn higher amounts in credit and land lower interest rates.

There are sound reasons that you might want to choose a HELOC as opposed to other lines of credit, like personal loans, for a home improvement. Making upgrades to your home can help increase its value and bring in more interest from future buyers if you plan to sell your home. Depending on your lender, it’s possible that you can also deduct the interest paid to put towards building or improving your home. Money spent towards home improvements may even be tax deductible, helping you to invest your money into your home.

HELOCs generally come with lower interest rates compared to some other types of loans. For example, you may want to take out a HELOC to pay off credit card debt that comes with higher interest rates. You could refinance the higher interest rates associated with your credit card by using a HELOC to pay off those debts and then paying off the HELOC loan that comes with a lower interest rate.

As an example, a HELOC may have (assuming you take the full loan amount):

  • Loan amount: $75,000
  • Interest rate: 5%
  • Draw period: 10 years
  • Repayment period: 20 years
  • Monthly interest-only payment during draw period: $312.50
  • Monthly principal and interest payment during repayment period: $494.97

As you can see, HELOCs can be quite beneficial depending on your financial situation. They can:

  • Provide an additional line of credit — this can be helpful if you are in need of emergency-related funds, such as large medical bills.
  • Come with lower interest rates — other lines of credit, such as credit cards, often come with higher interest rates.
  • Positively affect your credit score — if you manage your account responsibly, you can help build your payment history, a major factor when determining your credit score.
  • Help improve the value of your home — if you’re using a HELOC to upgrade or rebuild, you could potentially increase the value of your home and sell it at a higher price to future buyers.
  • Act like a second mortgage — a HELOC won’t affect your existing mortgage payments.

How a HELOC Can Affect Your Credit Score

A HELOC can have either a negative or positive impact on your credit history in several ways. Let’s look at some of the primary ways HELOCs can affect your credit score.

When You Apply for a HELOC

When you apply for a HELOC, a lender will make a “hard inquiry” to review your credit report. A hard inquiry stays on your credit report for two years and can lead to a small, but temporary, dip in your credit score.

Read Also: Comparing Bank of America HELOC

You can apply for a HELOC with several lenders so you can find the best rates without taking several hits to your credit score, by applying for them within a time period of about 14 to 45 days. So, several hard inquiries can have a similar impact as one inquiry would.

When You Make Payments on Your HELOC

Payment history also impacts your credit score. So, if you make timely payments on your HELOC, your credit score could improve. If you make payments past the due date or miss payments altogether, your credit score could take a hit.

When You Use Your HELOC

Credit utilization represents 30% of the widely used FICO score. Your credit utilization ratio divides the amount of revolving credit (typically credit cards) that you’re using by the amount of revolving credit available to you. For example, if you’ve got $30,000 in available revolving credit and you’re using $7,500, your credit utilization ratio would be 25%.

However, FICO does not include HELOCs in its calculation of credit utilization ratios because the loans are secured by a borrower’s home. Other credit-scoring models may take HELOCs into consideration.

The impact a HELOC has on your credit score depends on how you use the funds and manage the account. You can help your score by making on-time payments on your HELOC. Like with any credit account, however, if you’re late on a payment your score will suffer.

If you’re using a lot of the available credit on your credit cards, you likely have a high credit utilization ratio that is hurting your score. Using your HELOC to pay off those credit card balances—as long as you keep the balances at zero going forward—will lower your utilization and can give your scores a boost.

One common misconception about HELOCs is that the balance figures into your credit utilization ratio. But because a HELOC differs from other credit lines in that it is secured by your home, FICO® (the credit score used most often by lenders) is designed to exclude HELOCs from revolving credit utilization calculations.

Another thing to keep in mind: Your lender will perform a hard credit inquiry when you apply for a HELOC. Your score may drop by a few points (if at all), but the impact diminishes over time.

Is There a Downside to Having a HELOC?

Residential real estate just keeps on rising in value — and that means a home can be a valuable source of wealth to tap into. One of the most popular ways to do so is via a home equity line of credit or HELOC. Like a giant credit card, it allows you to borrow from your ownership stake (equity) as needed over a set time frame, and then repay it over decades. If you own a sizable amount of your home outright, you may have access to a five or even six-figure sum — often, much more than you could borrow with a personal loan.

There’s a lot to like in a HELOC. However, it also comes with risks. You must put your home up as collateral, and you pay interest at a fluctuating rate — which means it could rise, boosting your repayments dramatically.

Let’s look at all the pros and cons of a HELOC.

Pros of HELOC

  • Lower interest rates

While home loan interest rates overall have risen dramatically since 2022, HELOC rates still tend to be lower than those on credit cards and personal loans. If you qualify for the best rates, a HELOC can be a less expensive way to consolidate debt or finance a home renovation.

  • Flexibility

With a HELOC, you use the funds as you need them, then repay only what you borrowed (with interest). If you wind up needing less cash than you thought, you’ll have smaller repayments, too. In contrast, home equity loans and personal loans offer a lump sum that has to be repaid in full (also with interest), whether you use all of the money or not.

Most home equity lenders also offer flexibility in terms of how you access your HELOC funds, such as debit cards, checks, ATMs, and online transfers. In addition, some allow you to convert all or a portion of your HELOC balance to a fixed rate, so you won’t risk getting hit with higher interest later on.

Another point of flexibility: is repayment. Many lenders also offer an interest-only HELOC, with which you only pay interest — no principal — during the draw period (typically 10 years). Doing so helps keep your payments manageable. Of course, you can always opt to pay back the principal, all or in part, which in turn elevates your credit line.

  • Possible tax deduction

Even after the Tax Cuts and Jobs Act of 2017, you can still deduct interest paid on a HELOC if you use the money for home renovations. Specifically, the IRS allows deductions on the interest if the HELOC funds are used to “buy, build or substantially improve the residence.” You can only take the deduction up to a certain threshold, however, based on your total mortgage debt. You must also itemize deductions to take advantage of this write-off.

  • Potential boost to credit

Two of the most important components of your credit score are your payment history and credit mix. Adding a HELOC to your history and paying it on time can help boost your score. (However, keep in mind that changing your credit utilization ratio by taking on the HELOC could actually make your score go down, too.)

  • High loan limits

HELOCs are intended for large amounts — at least five figures. Frequently, $10,000 is the minimum credit line you can establish. The benchmark HELOC whose rate Bankrate tracks is for $30,000. Many lenders offer credit lines as high as $500,000 or $750,000.

How big your line of credit is, however, depends on the equity in your home — that is, how much of it you own outright. Generally, you can borrow up to 80 percent of your equity stake — sometimes as much as 90 percent, depending on the lender and your financials. However, your outstanding mortgage also impacts the amount of equity you can tap. When they say you can borrow up to 80 percent, they mean the sum total of all your home-based debt (current mortgage plus new HELOC) can’t exceed 80 percent of your home’s value. In financial-speak, this is called your combined loan-to-value ratio (CLTV).

For example: Assume your home is worth $425,000 and your outstanding mortgage balance is $250,000. This means you have $175,000 in equity and a loan-to-value (LTV) ratio of 59 percent ($250,000 / $425,000 * 100). Your lender lets you borrow up to 80 percent of your equity. That means if the lender approves you for a HELOC, your maximum credit line is $90,000 ($425,000 *.80 – $250,000).

Cons of HELOC

  • Rates are variable

While home equity loans come with a fixed interest rate, HELOCs have variable rates. This means that your rate can go up or down based on economic conditions,  the Fed’s monetary policy and other factors, which in turn affects your payments. Even if you take out a HELOC at a lower rate, you could face much higher interest rates when it comes time to repay.

  • House is on the line

A HELOC is a secured loan, meaning you put your home up as collateral. While secured loans tend to have lower rates, you’re taking on some additional risk by putting your house on the line. “Because you are borrowing against your home, if you can’t make your monthly payments, you risk foreclosure,” says Sean Murphy, assistant vice president of mortgage operations, closing at Navy Federal Credit Union.

  • Reduced equity cushion

When you borrow through a HELOC, you’re borrowing against your home’s equity. If home prices drop, you could wind up owing more than your home is worth. In addition, if your home is your largest asset, tying up your equity with a HELOC might limit additional opportunities to borrow, as well as the ability to leverage your equity in an emergency.

  • Potential to run up balance quickly

Because many HELOCs allow interest-only payments during the draw period, it’s easy to access cash without considering the financial ramifications. “If the borrower is not returning funds to this line of credit, then the loan eventually begins to amortize and the payments go up significantly,” says Joseph Polakovic, owner and CEO of Castle West Financial in San Diego. Bottom line: An unwelcome surprise can await you when the repayment period starts, if you haven’t expected/budgeted for a jump in your monthly payments.

HELOCs can be a good option if you have substantial equity in your home and you know you’ll need access to cash with some regularity over a period of time — college tuition bills over the course of several years, for example. If you’re looking to spend as you go, and only pay for what you’ve borrowed when you’ve borrowed it, a HELOC is probably a better option than a lump-sum home equity loan, says Murphy.

However, HELOCs can be risky. The variable interest rate could increase, and if you’re unable to pay back the loan for whatever reason, you could lose your home. In addition, you might end up with a false sense of bottomless funds during the draw period, which can make for a stark return to reality when the payback period begins.

Home equity lines of credit (HELOCs) are an option for disciplined borrowers who want to take advantage of the inherent wealth of their homes.  HELOCs have the most flexibility in terms of how much you can borrow and when you can pay it off, compared with other home equity products. Their structure can help you keep your monthly payments down and avoid unnecessary debt and interest.

However, HELOCs also have a variable rate, meaning you could pay a lot more in interest than you bargained for. And the sense of a seemingly limitless credit line could make them risky for less-disciplined borrowers.

When considering a HELOC, think honestly about your financial habits, the potential risks and the nature of your funding needs. HELOCs work best if you require an indefinite sum or need funds for an extended period of time. And the money should go towards improving your home or your financial profile.

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