Does A Heloc Affect Credit Score?
How does a HELOC impact your credit score?
HELOC is a versatile loan that can be effective for paying off credit card balances or for improving housing conditions. However, every time a new loan is taken, there is likely to be a negative impact on the credit score. Well, how does opening this particular product – HELOC – affect your credit?
What Is a HELOC?
HELOC stands for Home Equity Line of Credit – this is a revolving credit that uses the equity on the home as security. They often have adjustable rates where drawing and repaying on the line is possible up to the credit limit that has been given. These are normally specified to have 10 or 15 years of access or a draw period during which more funds cannot be borrowed. The ability to use HELOCs is convenient for regular and occasional borrowing as well as for large amounts of money.
How Does Applying for HELOC Affect My Credit Score?
Just applying for a HELOC will lead to a hard pull on your credit report as well, and note that there is a slight difference between both. The hard inquiry, in itself, will cost you a minor hit on your credit score – often, only a few points. This effect is only short-lived, and your score is likely to bounce back within a year of experiencing the impact. Hard inquiries are reported on your credit report for 2 years, but their effects in reducing your score gradually lessen over time. So long as you are not generating hundreds of hard inquiries within a relatively short period, an application for a HELOC in and of itself causes minimal and temporary credit impact.
How Does the Rate of HELOC Utilization Impact Credit Scores?
Far more critical than the application inquiry is how your utilization of the HELOC affects your credit score. This means the proportion of the amount you currently owe on the HELOC to the total credit limit offered. This is because high utilizations indicate high usage of credit products such as the HELOC and credit cards that are associated with more credit risk. Therefore, it is seen that higher utilization leads to a decrease in credit scores.
One of the issues with credit scoring models is that they do not distinguish between debt on HELOC and credit card balances. When calculating your utilization ratio, both types of revolving credit are grouped. This means that the utilization of funds from HELOC should be done wisely so as not to affect the credit score. A general rule of thumb is to keep the total revolving credit utilization below 30 percent. Any outstanding balance on the HELOC beyond this level is likely to attract a blow to your credit.
Does Opening a HELOC Deduct Points on the Credit Score?
Every time you add a fresh credit account, it is often likely to bring down the average age of your credit history. Since longer credit histories improve your score, getting a new HELOC could hurt your credit a couple of points in the process. However, two offsetting factors lessen the impact, In other words, two factors act as a buffer to the adverse effects of this development. First, the impact of the hard inquiry and the age effect are usually short-term and your credit score will recover soon afterward. Second, an additional credit account increases the total amount of credit available to the cardholder thereby decreasing the overall utilization ratio. When done wisely, this is useful to your credit score rating system as it will show that you are a responsible borrower and you have the capability of fulfilling your financial obligations and paying the amount borrowed whenever you are due to do so.
How Long Does HELOC Affect Credit Scores?
The direct inquiries and the age adjustments, that emerge from the opening of a HELOC, may negatively affect your credit report for up to two years. However, new accounts play a role in determining your score less frequently as time passes. As explained above, these influences only have a minor and temporary negative impact on credit score given that the rest of the profile is good.
Thus, the long-term credit effect is related to the use of HELOCs. If you can keep the utilization ratio below 30 percent, then the credit damage should not be significant. However, maintaining a high balance on your HELOC is not advisable since it has the potential to change your credit score profile for as many years as possible. If you continue to have high credit utilization, even after repaying the loan, it takes a toll on your credit score for several months.
Ways to Avoid HELOC Negative Impact on Your Credit Score
Follow these tips to reduce any undesirable impacts of a HELOC on your credit.
- Check the offers to reduce the number of tough inquiries – Several HELOC inquiries within a short time are suspicious.
- Do not apply for credit before paying off the other accounts – this helps to create a favorable profile.
- Pay on time – this is a major determinant of credit scores.
- Reduce your HELOC balance steadily – A high balance negatively impacts more than new credit.
- Maintain a low total utilization ratio – Monitor the balance in all the credit accounts.
- Debt consolidation – Borrow to repay high-interest debts.
The Bottom Line
The process of opening and using the HELOC may hurt your credit score. However, there are ways to manage credit responsibly to avoid long-term detrimental effects. Check your usage, keep the balances low, and practice good credit usage. Thus, with the proper consideration, HELOCs are not a bad option because they offer some additional freedom in financing without compromising creditworthiness.
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