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.
What Is a Home Equity Line of Credit?
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.
How Does It Work?
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.
How Does a Home Equity Line of Credit Affect Your Credit Score?
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.
Can I Get a Home Equity Line of Credit With Bad Credit?
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.
Some Considerations When Thinking About HELOC
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.
You can order a free copy of your credit report once every 12 months from each of the three national credit bureaus: Equifax®, Experian® and TransUnion®. Visit AnnualCreditReport.com or call 877-322-8228 to request your copies. The Federal Trade Commission notes that FreeCreditReport.com is the only authorized website to provide this information to you. Other websites that say they can provide this information are "imposters," according to the FTC.
- Consumer Financial Protection Bureau: What You Should Know About Home Equity Lines of Credit
- Federal Trade Commission: Home Equity Loans and Credit Lines
- Experian: Credit Scores and Your Home Equity Line of Credit
- Experian: What is a Good Credit Score?
- Bankrate: Home Equity Loans, HELOCs Catch Fire Again
- Federal Trade Commission: Free Credit Reports
- Discover.com. "How Home Equity Financing Works: Rates, Terms and Repayment." Accessed May 12, 2020.
- AnnualCreditReport.com. "The only source for your free credit reports. Authorized by federal law." Accessed May 12, 2020.
Victoria Lee Blackstone was formerly with Freddie Mac’s mortgage acquisition department, where she funded multi-million-dollar loan pools for primary lending institutions, worked on a mortgage fraud task force and wrote the convertible ARM section of the company’s policies and procedures manual. Currently, Blackstone is a professional writer with expertise in the fields of mortgage, finance, budgeting and tax. She is the author of more than 2,000 published works for newspapers, magazines, online publications and individual clients.