A HELOC is a home equity line of credit. HELOCs are different from traditional mortgages because they are open credit lines available for homeowners to take out the amount of money they need. On a credit report HELOCs are usually listed as revolving credit like a credit card, not a second mortgage. Too many open lines of credit can have a negative effect, and a HELOC could potentially reduce your credit score.
With a HELOC, you decide how much equity from your home to use. For example, say you have $100,000 available in equity. The lender will set up a revolving account, so you can take out as little or as much of that $100,000 as you need, and you can use it for any expenses you wish. Because it has a minimum monthly payment and a limit, a HELOC can directly affect your credit score since it looks like a credit card to credit agencies.
It's important to manage the amount of credit you have since a HELOC typically has a much larger balance than a credit card. It may also be a good idea to pay off your other credit card balances with the HELOC, so you only have one balance to manage. If you have too much debt and too many lines of credit, your credit score can be affected.
Another way that opening a HELOC can affect your credit score is from the fluctuating payments. Since a HELOC has a variable interest rate, payments can increase when interest rates rise and decrease when interest rates fall. This variability can make it challenging to budget when you don't know what your payments will be in the future. If your payments increase too much, you may want to consider refinancing your HELOC.
Does a HELOC hurt my credit score?
Using all the available credit on your HELOC may have a negative effect on your credit score because it's an indicator of high risk even if you make payments on time. By using all your available credit, you don't have room for unexpected expenses like a medical issue or a leaky roof or car repair. You don't want to max out your credit cards or a HELOC and have no emergency source of funds. On the other hand, if you use your credit strategically, a HELOC can affect your credit score positively and boost your financial situation. Plus, as you pay down your HELOC, your credit score should improve.
Will closing a HELOC affect my credit score?
Part of your credit score is determined by your credit utilization, which is how much credit you are using. Closing a HELOC decreases how much credit you have, which can hurt your overall credit score. However, if you have other credit lines besides a HELOC like credit cards, then closing it may have minimal effect on your credit score. Another reason to close the HELOC if you don't need to take any more money out or if you pay off the balance is that it will close out the lien on your home that a HELOC puts in place as collateral. If you want to sell your home and purchase another, then you would first need to close out the HELOC.
Learn more about the differences between HELOCs, cash out refinances and home equity loans. Freedom Mortgage offers cash out refinances to help customers borrow against the value of their home equity.
Freedom Mortgage Corporation is not a financial advisor. The ideas outlined in this article are for informational purposes only, are not intended as investment or financial advice, and should not be construed as such. Consult a financial advisor before making important personal financial decisions, and consult a tax advisor regarding tax implications and the deductibility of mortgage interest.