How Does A Home Equity Line of Credit or Loan Affect My FICO Score?
If you take out either home equity line of credit or home equity installment loan, it will affect your credit depending on which type of loan you take. And if you decide to take out a home equity line of credit (HELOC) rather than the installment loan, how it is classified in your credit reports may affect how it affects your credit as well.
To understand the situation, it is important to note that FICO classifies credit as either installment or revolving credit. Installment credit includes mortgages, auto loans and home equity installment loans. These loans are fixed and get paid off over time. Things like credit cards, on the other hand, are classified as revolving line of credit. In a typical revolving credit like credit cards, you are given a line of credit and you are free to choose how much to draw and how long you wish to pay it off.
If you take out a HEIL (home equity installment loan), then it will be clearly classified as an installment loan. The great thing about installment loan is that credit utilization is not a factor. For example, if just took out a $100,000 mortgage, and you still have $95,000 left, myFICO will not do calculations that imply that since you have 95% of the balance to be paid that it is bad. Hence, having a home equity line classified as an installment loan is a great thing.
But the situation gets a little trickier with a HELOC. In some cases, a HELOC is considered a revolving line of credit whereas in other cases, it is considered an installment loan. There have also been reports that different credit bureaus consider them differently depending on the amount of credit lines issued1. So one might have a situation where one credit bureau reports as a revolving line of credit whereas another reports as an installment loan.
Fair Isaac (the company behind the FICO score) is not very clear about the situation as well. Their spokesperson Craig Watts has said that if the amount of HELOC is small (perhaps $10,000 to $20,000 range), it will be considered a revolving line of credit. If it was larger, it would be considered an installment loan. However, Fair Isaac has refused to put a fixed number for the cut off point!
If a HELOC is treated as an revolving loan, then the concept of “credit utilization” comes into play. If you took out a $30,000 HELOC and used $25,000 for a kitchen renovation, then that would increasing your credit utilization ratio (depending on how much credit lines you have and use with your other revolving credit like your credit cards). Hence if you intend to use up the bulk of your HELOC, it is perhaps better to get a HEIL since using up 95% is alright if it is classified as an installment loan. But it also depends on how much credit lines you have on your other revolving credit and how much you are using them. Using the same example, if you have a $200,000 limit on credit cards and using only $10,000, then using up that $30,000 HELOC would probably not do too much harm. But if you only had $10,000 in credit card lines and used up $3,000, then using $25,000 of the $30,000 HELOC will probably not be such a good idea from a credit score perspective.
Another risk you face when it is classified as a revolving credit is that if your bank perceives that your home value has fallen, it will reduce your credit lines. In fact, a lot of that happened during the financial crisis in 2008 and 2009 and many folks had their credit scores reduced as a result of that. On the other hand, if the HELOC is classified as revolving credit and you only use 10% of the lines, then that will improve your credit score because your utilization ratio will improve.
I could see another situation where having a HELOC classified as a revolving credit might help as well. For example, for someone who does not have any credit cards, having a HELOC classified as revolving credit (and using very little of it) will help give you a more “diversified” credit mix. Having a diversified mix of credit also aids your score.