Does a HELOC Affect Your Credit Utilization?
Understand the interplay between a HELOC and your credit utilization to manage your overall credit health effectively.
What is a Home Equity Line of Credit (HELOC)?
A Home Equity Line of Credit, a HELOC, is a revolving credit line secured by home equity. Unlike a traditional mortgage, a HELOC functions much like a credit card, allowing access to funds up to a predetermined limit. Homeowners can draw, repay, and redraw funds as needed, similar to a credit card.
HELOCs have two phases: a draw period and a repayment period. During the draw period, which can last up to 10 years, borrowers can access funds and often make interest-only payments on the amount borrowed. Once the draw period concludes, the repayment period begins, requiring principal and interest payments, usually over 10 to 20 years, until the balance is repaid. As secured debt, the home serves as collateral, allowing the lender to foreclose if payments are defaulted.
Understanding Credit Utilization
Credit utilization measures the amount of revolving credit an individual is currently using compared to their total available revolving credit. It is calculated by dividing total outstanding revolving debt by total available revolving credit. For example, $1,000 in debt on $5,000 in limits results in 20% utilization.
This ratio is important in credit scoring, second only to payment history. A lower ratio indicates responsible credit management and lower risk to lenders; a high ratio signals financial stress or higher default likelihood. Financial guidance suggests maintaining a credit utilization ratio below 30% across all revolving accounts to positively influence one’s credit score.
How a HELOC Influences Credit Utilization
A Home Equity Line of Credit is typically reported to credit bureaus as a revolving credit account. When a HELOC is opened, its entire credit limit becomes part of the homeowner’s total available revolving credit. This inclusion can immediately impact the credit utilization calculation, even before any funds are drawn.
The actual impact on credit utilization becomes apparent when funds are accessed from the HELOC. Any outstanding balance on the HELOC contributes to the total revolving debt in the credit utilization formula. For example, if a homeowner has a $100,000 HELOC limit and draws $20,000, that $20,000 is added to their total revolving debt, directly influencing their overall credit utilization ratio.
A large HELOC limit can lower overall credit utilization if other revolving debts are stable and the HELOC is not heavily drawn. This is because the large limit increases total available credit, diluting the impact of existing credit card balances. Conversely, drawing a substantial amount from a HELOC significantly increases utilization, negatively impacting the credit score. Even if a large draw is a small percentage of the HELOC’s high limit, it still adds to cumulative revolving debt.
Other Credit Score Factors Related to HELOCs
Beyond credit utilization, a Home Equity Line of Credit can influence other credit score components. Payment history is the most significant factor; consistent, on-time payments contribute positively, while late or missed payments can substantially damage a score.
Opening a new HELOC can also have a minor, temporary effect on the length of credit history. A new account slightly reduces the average age of all credit accounts on an individual’s report. This impact is typically minimal and diminishes over time as the HELOC account ages.
A HELOC can further diversify an individual’s credit mix, another element considered by credit scoring models. Adding a new type of revolving credit, especially if only credit cards or installment loans were present, can be viewed favorably. The application involves a hard inquiry, causing a small, temporary dip in the credit score. This inquiry remains for up to two years, though its impact lessens over time.