Does Heloc Affect Credit Score?
A HELOC can be a valuable financial product that enables homeowners to obtain funds for home remodeling, consolidation of debts, medical bills, or tuition fees. However, those who are planning to open a HELOC should first learn the effects of this loan on their credit rating. Here are some pointers to consider when it comes to how a HELOC may impact credit.
What Is a HELOC?
A HELOC is a type of credit that one has access to and is tied to the value of the house. Like a credit card, it enables you to take funds against the amount of home equity available on the house up to some extent. Because HELOCs work as lines of credit, as you gradually pay off your balance, that credit is still available to use again. HELOC interest rates are adjustable but are generally lower than other forms of credit.
Home Equity Line of Credit vs Home Equity Loan
A HELOC is a line of credit, but a home equity loan gives you a check in hand with the agreed amount of money. You would repay the loan for home equity in fixed monthly installments just like any other loan but over a certain period. Another positive feature of a HELOC is that it allows borrowing only the amount required.
The Effects of HELOCs on Credit Ratings
Each time you apply for HELOC, the lender is going to pull your credit report for your application purposes. This results in a slight reduction of credit scores for a short period say between five to ten points. The exact amount depends on your credit profile and credit history peculiarities as well as your credit score. Depending on the credit rating of the borrower, the drop may be towards the lower end of that range.
Utilization Rate
If you use your HELOC and have a balance that you rolling over to the next month, this balance will be reflected in the credit bureaus. The ratio of the amount of money owed to the credit limit is referred to as the credit utilization ratio or percentage. It is advisable to maintain the utilization ratio below 30% for all credit cards and lines of credit. When your credit limit of the HELOC is closer, your credit score can drop.
Payment History
This means that how you pay your bills contributes to your credit score hugely. Every payment made on time in the HELOC credit line reflects positively on your credit reports. Nonetheless, failure to honor payments or becoming a defaulter of your HELOC can lead to more significant declines in the score. They also remain on your credit reports if you paid them late, and these can also be there for as long as seven years.
Credit Inquiries
Requesting for new lines of credit frequently also has the effect of portraying the company as high risk to lenders. Credit inquiries are reported for two years but affect scores for only one year. Extended HELOC pre-shopping and rate checking translate to multiple inquiries in a short period, and this is a no-no to FICO and VantageScore scoring models.
Age of Credit History
Other aspects of credit scoring models include the average age of your credit accounts. Since it means that the average age of the other accounts is lower when a new HELOC is opened, it may cause a slight temporary change in the credit scores. But it probably won’t overshadow the benefit of being sensible when it comes to another form of credit.
Ways to Reduce the Effects of HELOC on Credit Scores
If you plan to apply for a HELOC soon, take steps to keep your credit scores as high as possible beforehand.
- Ensure that all the bills due before your application are paid in full
- Do not apply for credit in the months leading
- Make monthly payments toward outstanding balances
- Look for errors that could be corrected in the reports
- You might want to suggest to your co-applicants who have better credit scores to apply with you
When you have an account with your HELOC, ensure that you do not use it haphazardly so that you do not go up in utilization and make your monthly payment on time. Avoid accumulating too large balances on your cards and, even if you borrow a significant sum of money, try to pay off the money relatively quickly.
Also, do not keep using and repaying your HELOC just to get access to more credit. FICO scoring models in particular, for example, will view frequent fluctuation of credit limits unfavorably.
Pros and Cons
If your credit scores decline because of a HELOC, then it may turn out difficult for you to borrow at reasonable rates shortly. However, if well utilized, HELOC can be used to pay off other expensive debts, fund repair and maintenance of the house to avoid depreciation of the property, or meet emergency medical bills.
Home equity line of credit should be followed after making the right decision and it is crucial to consider the financial and credit aspects of it. One should keep checking their credit scores and credit reports frequently, especially throughout managing their credit. A first small one is perhaps worth the utility of fairly using an inexpensive HELOC.
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