How a HELOC can help (or hurt) your creditworthiness

A home equity line of credit (HELOC) can be a credit nightmare or a credit dream depending on how you use it.

Using home equity to fund expenses like debt consolidation, home improvement, and education is now more accessible. According to the Homeowner Equity Insights report by housing data firm CoreLogic, the average homeowner’s equity rose to over $ 200,000 in the past year.

This loan product uses the value of your home to secure a line of credit that can be paid off over a period of years. Failing to repay the debt is risky as the bank could seize your home. However, a HELOC can be an attractive loan option if you are in good financial standing and believe you can make the monthly payments.

Acquiring a HELOC can be a good, albeit risky, way of capitalizing on the wealth of your home. If used responsibly, a HELOC can actually help you increase your score. And as with any debt or loan, a HELOC has a negative impact on creditworthiness if misused.

Here are the creditworthiness impact of a HELOC and what to consider before proceeding.

What is a HELOC?

“A HELOC is a revolving line of credit where a borrower uses the equity in their home to purchase funds that will be repaid over the life of the loan, much like taking out a second mortgage,” said Nicole Christopherson, real estate agent at NMC Realty in California.

“What sets HELOCs apart is that the borrower is not paid the full amount in advance; it’s more like a credit card, ”says Christopherson. Borrowers use a line of credit, typically capped at 60 to 70% of the value of a home, to borrow money during the “draw” phase. The repayment periods can be up to 20 years, the borrower then pays back the remaining amount owed in monthly installments plus interest.

HELOCs are similar to credit cards in which lenders can offer different interest rates, credit limits, and minimum payments, according to Ryan Cicchelli, founder of Generations Insurance & Financial Services, a Michigan health and retirement company. HELOCs tend to have lower interest rates than credit cards and can be easier to come by for those with poorer creditworthiness, Cicchelli adds.

How a HELOC can damage a credit rating

“If you are someone with less tax responsibility or are trying to get a HELOC at a turbulent time in your life, you could have a serious impact if it is approved,” says Cicchelli. For this reason, it is important to check your credit history before accepting a HELOC.

Please note the following:

Credit check: Whenever a lender checks your credit score – known as a hard credit request – it can easily lower your score. These point things stick on your credit report for up to two years. Applying for a HELOC is considered a tough loan application and has similar results.

Variable payments: HELOC payments may fluctuate due to the variable interest rate. This can make budgeting a challenge when payments become unmanageable. With on-time payment history accounting for 35% of creditworthiness, any missed HELOC payment is detrimental.

Loan utilization: Just because you can borrow a certain amount doesn’t mean you should. Using all of your available credit with a HELOC is considered high risk credit report behavior. “If you have a $ 100,000 line of credit and you pull it all out at once,” said Mayer Dallal, managing director of Mortgage Bank of California, “treats it like a line of credit has been used up.”

Overstrain yourself: If you borrow too much of your available credit line, your credit budget will not have room for unplanned emergencies such as car repairs or medical expenses. It is recommended that you build an emergency savings fund first before borrowing through a HELOC. However, if you don’t have an emergency fund and need a HELOC to finance an emergency, leave room in your credit line for other emergencies. If you run out of HELOC funding and a financial emergency occurs, you run the risk of missing payments, which is the biggest contributor to creditworthiness.

Closing a HELOC: Closing a line of credit can have a negative impact on your creditworthiness. The effect can be greater if your HELOC is one of the few lines of credit you have.

How a HELOC can improve your creditworthiness

“As long as you don’t overwhelm yourself, have too many high-balance lines of credit, make timely payments, and manage your HELOC as well as you should with any other debt, you will see positive results on your credit report,” says Cicchelli. “If you falter in any of the above areas, you will see the effects.” Here’s how to use a HELOC as an opportunity to improve your creditworthiness.

Loan utilization: By using the HELOC funds to pay off debt, Christopherson says you can reduce your credit load and improve your credit score.

Knowing how much debt you have and how much you can comfortably borrow can be worth it, says Cicchelli.

Loan utilization: However, as you pay off your HELOC balance, your credit utilization – which represents 30% of your score – will decrease over time and your score will improve.

On-time payments: By paying your HELOC on time and in full each month, this behavior is well reflected in the credit report and can only improve or maintain your credit score.

How to prepare your credit for HELOC. before

Paying off other debts: Too many open credit accounts can degrade your credit score. It is a good idea to settle other debts before entering into a HELOC. This will help to offset any overstretching of your overall credit limit, negatively affecting your credit utilization, and ultimately your credit score.

Existing equity: One of the most important factors in getting a HELOC, according to Christopherson, is that you already have 15-30% of the equity in your home. “This is one of the most important factors in how much you can ultimately borrow, which is typically 85% of your combined mortgage lending value,” she says.

Decrease DTI: Your Debt-Income Ratio (DTI) is an indicator of how much debt you can borrow, and is a number that most lenders look at outside of your creditworthiness. Most lenders prefer a DTI of less than 43%. If more than 43% of your income is being used on debt, then you should work on lowering that amount first before taking out another loan such as a HELOC.

Improve Your Credit Score: The ideal credit score for getting the best HELOC interest rate is 720+. How To Improve Your Overall Credit Score:

• Make payments on time across all of your accounts.
• Keep old credit accounts open.
• Look for a healthy mix of installment, revolving, and open credit.
• Monitor how often you take out new credit accounts.
• Healthy Loan Utilization Management – Your Total Debt Percentage.