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 you pursue this option, you might wonder: Does a HELOC affect your credit score? After all, most loans and debts do.

In this regard, 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. As additional debt, it can ding it — but can also boost it as an enhancement of your total available credit.

Basically, a HELOC’s impact on your credit score usually comes down to how you manage the account.

“A HELOC can affect your credit score — it all depends on how you use it,” 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

A HELOC can affect your credit even before you actually get it. When you apply for one, the lender will check your credit score. This “hard pull” or “hard check” has the potential to temporarily lower the score. “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, Partner Relations at Money Management International, a Texas-based nonprofit debt counseling organization.

And if you haven’t applied for other credit 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, 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.

Once you’re approved, the HELOC will be reported on your credit report as if it were revolving credit, instead of a second mortgage. “A HELOC is an open line of credit and subject to being used in the same manner [as a credit card],” says Boies.

With a home equity line of credit, you can borrow money against your credit when you need to and make only minimum payments during the draw period. “That’s why a HELOC is listed as a revolving account like your other credit card accounts,” says Mink. “The credit report will show the HELOC balance, credit line and payment history.”

Unlike a credit card, however, the outstanding balance of the HELOC is not considered when you’re seeking another loan; it won’t affect the calculation of your credit score.

What happens to your credit score 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. So you don’t get points for not tapping the HELOC balance, and you’re not penalized for using all of the available credit in your HELOC — unlike with a credit card, where it’s recommended to not to use more than about 30 percent of your limit.

How a HELOC can improve your credit score

How does a HELOC affect your credit positively? It all comes down to how you use the line of credit.

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 rather than a credit card 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.

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 30 percent of your credit score, this can help you give your score a notable bump.

Using your HELOC to pay off other loans or balances (especially on credit cards) may also result in a score increase — if the net amount of debt you’re carrying decreases overall.

How closing a HELOC affects your credit

Closing a HELOC can impact your credit score, especially if you don’t have much credit available elsewhere. “Closing a HELOC will reduce one’s available credit and could have a negative impact if the percentage of revolving balances breaches a certain percentage,” says Matt Hackett, operations manager of Equity Now, a New York-based direct mortgage lender.

For instance, if you have a HELOC for $10,000 and close the account after it is paid off, that means the $10,000 of available credit is no longer being factored into your credit score.

In other words, while the size of your HELOC balance may not affect your credit score all that much, the presence of the balance itself does.

The impact to a credit score will be greater if the person has a short credit history, is relatively new to credit 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 45-day window. FICO considers similar inquiries that have occurred within 45 days 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.”

Bottom line on HELOCs and credit scores

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 HELOCs tend to have lower interest rates than credit cards or personal loans, they could make the most financial sense.

“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 on your salary or with savings, 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 to delay dealing with the principal.