What is a Home Equity Line of Credit?

The equity in your home may be a source of credit that’s available to you on an ongoing basis. Although you can use this credit however you want, most consumers earmark the funds for significant purchases such as medical bills, home improvements or education expenses. A home equity line of credit also offers many people a cushion for unforeseen expenses.

Also known as a HELOC, a home equity line of credit is a revolving credit account that uses the equity in your home as collateral for the account. Your equity is the portion of your home’s value that remains after you subtract the amount you still owe on your mortgage loan from your home’s fair market value, which is typically determined by a property appraisal. For example, if your house appraises at $180,000, and you owe $130,000 on your mortgage loan, your home equity is $50,000. A home equity line of credit allows you to borrow a portion of the $50,000, depending on the terms of your HELOC.

A home equity line of credit works similar to a credit card. You have an available line of credit, which you can use as you need it by writing a check or using a credit card that’s attached to your account, depending on how your HELOC is structured. You repay the credit by making monthly payments on the actual amount you borrowed not the amount that's available to you. You only have to make the minimum monthly payment, and you can carry the remaining balance from month to month. Your lender determines your credit limit by considering your credit score, your other debts and the amount of equity you have in your home.

A home equity line of credit can affect your credit score either positively or negatively. Your credit report includes details of your HELOC, which include your credit limit, the amount you’ve borrowed against the limit and whether you’ve made timely payments. Late payments adversely affect your credit score, but even if you always make your payments on time, your score may still be negatively affected. The reason for this is how credit bureaus evaluate your credit. Experian®, one of the three nationwide credit reporting agencies, notes that when a consumer maximizes her home equity line of credit, it usually indicates that she is a high credit risk even if she has no late payments.

Although it’s possible to get a home equity line of credit with bad credit, you may have to shop around to find a willing lender. Although “bad” credit may be a subjective term to many people, Experian breaks down credit scores on its FICO rating scale. “Very poor” translates to “bad,” and this category carries a maximum score of 579. Since most lenders require a minimum credit score of at least 620 to extend a home equity line of credit, you'll have your work cut out for you if your score is lower than that.

A home equity line of credit may ease a financial hardship, but the Consumer Financial Protection Bureau underscores the inherent risk you take when you offer your home as collateral for any loan or line of credit. If you’re unable to pay your debt, you may lose your home. Most HELOCs allow the lender to freeze or reduce your credit if your home substantially declines in value, or if the lender believes that you may have difficulty making your payments because of a significant change in your financial health. If this happens, you may need a new appraisal or you may have to correct any incorrect data, which may have been erroneously posted on your credit report.