How Getting a Home Equity Loan Could Affect Your Credit Score

Tapping into your home's equity can be a savvy financial move, but it's not without consequences for your credit. This new loan can influence your credit score in several distinct ways.

1. The Hard Inquiry: When you apply, lenders pull your credit report, resulting in a hard inquiry. This action can cause a small, temporary dip in your credit score for a few months.
2. New Account and Credit Mix: Once approved, the loan appears as a new installment account on your credit report. This can positively impact your credit mix, which is a factor in scoring models.
3. Increased Debt Load: The loan adds to your total debt. While it's a secured loan, a significant increase in your overall debt can be a negative signal and may affect your score.
4. Ongoing Payment History: Making consistent, on-time payments is the most critical factor. A positive payment history on the loan will help build your credit score over time, while missed payments will damage it.
5. Average Age of Accounts: Opening a new loan lowers the average age of all your credit accounts. This can have a slight, temporary negative impact on your score, which will diminish over time.

How Much Will Getting a Home Equity Loan Affect Your Credit Score?

Taking out a home equity loan can influence your credit score in several ways, both during the application process and over the life of the loan. Here are a few key considerations to keep in mind.

• Hard Inquiry. Applying for the loan triggers a hard inquiry on your credit report. This can cause a temporary, minor dip in your score, but the effect typically fades within a few months.
• Increased Debt Load. This new loan increases your total debt, which can affect your debt-to-income ratio. Lenders consider this ratio when evaluating your financial health for any future borrowing needs you may have.
• Credit Mix. Adding an installment loan can diversify your credit mix, which may positively impact your score. A healthy mix of credit types shows lenders you can responsibly manage different kinds of debt.

How You Can Avoid Having a Home Equity Loan Affect Your Credit Score

Make On-Time Payments

The most crucial factor is consistently making your payments on time. Lenders report payment history to credit bureaus, and even one late payment can negatively impact your score. Set up automatic payments to ensure you never miss a due date and protect your credit history.

Manage Your Overall Debt

A home equity loan increases your total debt, which affects your credit utilization ratio. To mitigate this, try to pay down other debts, like credit card balances. Keeping your overall debt low demonstrates responsible credit management and can help offset the impact of the new loan.

Ways to Improve Your Credit Score

Improving your credit score is an achievable goal that relies on consistent, positive financial behavior. By following a few proven methods, most people can see meaningful changes to their score within three to six months.

• Monitor your credit reports regularly. An expert guide recommends getting free reports from the three major bureaus to check for inaccuracies that could be dragging down your score.

• Establish automatic bill payments. Your payment history is the single most important factor in your score, so setting up automatic payments is a simple way to ensure you never miss a due date.

• Reduce your credit utilization ratio. Aim to use less than 30% of your available credit, as high balances can signal financial distress to lenders.

• Become an authorized user. If you have a trusted friend or family member with a strong credit history, being added to their account can help you benefit from their positive payment history and low utilization.

• Diversify your credit mix. Lenders prefer to see that you can responsibly handle different types of credit, such as revolving credit (credit cards) and installment loans (car loans, mortgages).

• Limit hard inquiries. Applying for too many new credit accounts in a short time can temporarily lower your score, so space out your applications and use prequalification tools when possible.

The Bottom Line

A home equity loan will affect your credit score. The application results in a hard inquiry, but responsible management and timely payments can help build a stronger credit history over time.

Frequently Asked Questions

Will applying for a home equity loan hurt my credit score?

Applying triggers a hard inquiry, which can temporarily lower your score by a few points. The effect is usually minor and diminishes over a few months.

How does a home equity loan appear on my credit report?

It is listed as a new installment loan. This increases your total debt but also diversifies your credit mix, which can be a positive factor over time.

Can a home equity loan improve my credit score?

Yes, making consistent, on-time payments demonstrates financial responsibility. Using it to consolidate high-interest revolving debt can also lower your credit utilization ratio, boosting your score.