Will applying for HELOC hurt my credit score?
Q: I am thinking about applying for a home equity line of credit. I don’t think I will draw on it frequently, but I may use it to help my daughter buy a home or do some work around the house. My credit score is pretty good. Would this HELOC hurt my credit score?
A: A home equity line of credit, also known as a HELOC, is a revolving line of credit very similar to a credit card. The main difference is that credit card borrowing is unsecured whereas the HELOC is secured by the equity in your home. The security provided by your home equity means the interest rate on your HELOC will usually be much lower than the rate on a credit card. HELOC interest is also tax deductible if the borrowing is used for home improvements and to the extent your overall mortgage borrowing (mortgage + HELOC borrowing) is below $750,000. Interest on a HELOC used to pay for things other than home improvements is not tax deductible.
Whether you are buying a car, getting a new credit card, taking out a student loan, or applying for a HELOC, a potential lender is almost always going to run your credit. Credit inquiries tied to an actual credit application are called “hard inquiries” and they will affect your credit score. According to FICO, one of the main credit scoring services, a hard inquiry will reduce your score by 5-10 points. That’s the bad news.
The good news is that the hit to your score from a hard inquiry diminishes rapidly. In fact, according to the credit reporting service Experian, the impact of a hard inquiry should mostly dissipate within a month or two. “Either there will be a new account on your record, which then becomes the key risk indicator, or there is no new account, which means the inquiry doesn’t represent any risk.”
It is a good idea to pay attention to the number of hard inquiries you generate. Too many hard inquiries may be a red flag to credit agencies warning of an impending change in your credit worthiness. However, most credit scoring models are designed to count multiple inquiries within a brief period of time as only one inquiry, since that kind of activity usually indicates the borrower is shopping for the best rate—especially when you have a strong score to begin with.
Once you open a HELOC, the new loan will show up on your credit report just like any other revolving line of credit. And just like your credit cards and other consumer debt, the way you service the HELOC will have a huge impact on your credit rating. Payment history is, by far, the largest factor in determining your credit score.
A late payment can knock as much as 100 points off your credit score. However, if you are a only few days late, don’t worry. Even if your lender charges you a late fee, you may still avoid a hit to your score if you remedy the late payment quickly. Federal law requires that a payment be at least 30 days late before a lender can report you to one of the major three credit bureaus: Equifax, Experian and TransUnion.
Wisely using your HELOC can help improve your credit score. Borrowing modestly against it and then making consistent on-time payments will demonstrate the soundness of your credit. Gradually, over time, your good payment performance will increase your credit score.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.