Depending on how it is used, a home equity line can either be a nightmare or a dream credit card.
It is easier to tap into your home equity to finance expenses like debt consolidation, home improvement, and education. According to CoreLogic’s Homeowner Equity Insights report, the average homeowner equity has increased to more than $200,000 over the past year.
The loan product is secured by your home’s equity and can be repaid over a number of years. This is a risky decision if you don’t pay the debt on time. Your house may be taken over by the bank. A HELOC could be a good loan option for you if your financial situation is stable and you believe you can make the monthly payments.
What is a HELOC?
Nicole Christopherson, realty broker at NMC Realty in California, says that a HELOC is a revolving credit line in which a borrower uses their equity in order to obtain funds that will be repaid over a term of the loan. It’s similar to taking out another mortgage.
Christopherson says that HELOCs are different because the borrower does not advance the full amount upfront. It acts more like a credit-card. Borrowers take out a line credit that is typically limited to 60% to 70% of the home’s worth to borrow funds. The borrower then pays the balance due in monthly installments and interest.
- A HELOC can damage your credit score
Cicchelli says that if you have less financial responsibility or try to obtain a HELOC during a difficult time in your life, there could be serious consequences. It is important to review your credit history before you apply for a HELOC.
Here are some things to keep in mind
Credit Check: A lender may check your credit, also known as a “hard credit inquiry”, which can slightly lower your score. These points can stay on your credit report up to two years. The application for a HELOC is considered hard credit inquiries and can lead to similar results.
Variable payments: HELOC payments are subject to fluctuation due to the variable interest rate. If payments are not manageable, this can make budgeting difficult. A missed HELOC payment can be detrimental as it accounts for 35% credit score.
Credit Utilization: You don’t have to borrow a specific amount just because you can. Credit reporting considers it high-risk to use all your credit available with a HELOC. Mayer Dallal is the managing director of Mortgage Bank of California. He says that if you have $100,000 in credit and then take it all out at once, it’s considered high-risk behavior for credit reporting.
Don’t overextend yourself: If you borrow more than your credit limit, it won’t allow for room in your borrowing budget to cover unplanned expenses such as car repairs and medical bills. Before you borrow through a HELOC, it is advisable to have an emergency savings account. If you do not have an emergency fund, but need to borrow a HELOC for an emergency, make sure that your credit line is available for other emergency situations. You are at greatest risk of missing payments if you have no HELOC funding or a financial emergency occurs.
How a HELOC can improve your credit score?
Cicchelli states that credit reports will improve if you don’t overextend yourself or have too many credit cards with high balances. You should also make timely payments and manage your HELOC as you would any other debts. You will notice the consequences if you fail to follow the above guidelines. Here’s how to use HELOCs to increase your credit score.
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Credit Utilization: Christopherson says that by using the HELOC funds for any debt you can lower your credit utilization and increase your credit score.
Credit Utilization: Pay your HELOC on-time and in full every month. This behavior will reflect well on your credit report and help to improve or maintain credit scores.
How to prepare your credit for a HELOC?
Reduce your credit score by settling other debts. Having too many credit accounts open can lead to a decrease in credit scores. Before you apply for a HELOC, it is a good idea. This will offset the overextension of your total credit limit, which can negatively affect your credit utilization ratio and eventually your credit score.
Christopherson says that having 15%-30% equity in your home is a key factor in getting a HELOC. She says that this is a significant factor in how much money you can borrow. It is typically 85% of your total loan-to-value ratio.
Diminish your DTI A DTI of less than 43 percent is preferred by most lenders. You should reduce the amount of debt you owe before you apply for a loan, such as a HELOC, if more than 43%.
You can improve your credit score by 720+ credit score. This is the ideal credit score for getting the highest HELOC interest rates. To improve your credit score overall:
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- All accounts must be paid on time
- Credit accounts that are older should be kept open.
- You should have a healthy balance of open, revolving and installment credit.
- Keep track of how often you open new credit accounts.
- A healthy credit management system will reduce your total debt.