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What is the effect of a HELOC on my credit score?

 

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Question:

What is the effect of a HELOC on my credit score?

Answer:

The credit agencies views Home Equity Lines of Credit (HELOCs) as revolving credit and does not distinguish them from a credit card. Just as your credit cards, your HELOC has a current balance and a maximum balance.

That's why it can be wise to dimension the HELOC a little bigger than what you really need. E.g. if you need $25k for repairs and have $100k of equity, I would make it a $50k HELOC and utilize only $25k of it.

The reason is, just as with credit cards the ratio of utilized credit to maximum credit is considered a measure of financial stability. Clearly this makes sense for credit cards where the debt is accumulated over time, usually for spending.

It makes less sense and is unfair in a situation when the HELOC is used as a down payment in a house purchase. I know people who bought a house with 80% financed in their first mortgage and the remainig 20% come from a HELOC that was created at the time of purchase. The benefit of the HELOC over a second mortgage is that it does not require PMI.
In this situation the buyer does not have the possibility to make the HELOC twice the size of what is needed.

So: The disadvantage of the HELOC to cover the remaining 20% is that you are adding a 'maxxed out card' to your portfolio of accounts.

As you pay down your HELOC, your credit score will rise.


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