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Beware of Home Equity Lines of Credit (HELOC)

By Erik Folgate

When it’s time to tap the equity in your home, you usually have two options: a home equity line of credit (HELOC) or a home equity installment loan (HEIL). Both will get you the money you want, but one may lower your credit scores, which will make everything you buy on credit more expensive – be careful.

So, which one is dangerous and which one is safe? A HELOC can potentially lower your credit scores. Here’s how. HELOC accounts can look exactly like a credit card account on your credit reports, and that can be a bad thing

When a HELOC is mistaken as a credit card and it’s maxed out it looks like you have a high-limit credit card and you’re using all of its available credit – which significantly lowers your credit scores.

However, Fair Isaac Corporation (the company who created credit scoring) states there are two situations when a HELOC won’t be mistaken as a revolving credit card:

  1. When the original amount of the line of credit is more than $50,000
  2. If the account has a narrative attached to it (e.g., equity line of credit or real estate)

Even though Fair Isaac claims the above is true, it isn’t always the case with HELOCs.

What’s Better – a HELOC or a HEIL?

There are a couple of important differences between a HELOC and a home equity installment loans. Once you understand the differences you can strategize on what’s best for your credit and financial situation.

Here are the differences:

A HELOC is a revolving loan (like a credit card). This means you can have variable monthly payments determined by the balance you owe each month. A HELOC also allows you to take some or all of the available credit out as you need it…just like a credit card.

A HEIL is an installment loan (just like a car loan or mortgage). This means you’ll have the same payment every month until it’s paid in full. A HEIL lets you take out only a fixed amount in one lump sum.

A HELOC could be mistaken as a credit card account by the FICO scoring model because they report as revolving accounts. However, a HEIL cannot be mistaken as a credit card account because a HEIL appears on your credit reports as an installment account.

Because of the effect HELOCs may have on credit scores, consider using HEILs to tap equity in your properties even though the interest rates are usually higher.

Protect Yourself Against Holes in the Credit System
Here’s a strategy you can use to insure yourself against the flaws we’ve been talking about in the credit system. If you want to tap into your home’s equity, apply for the highest HELOC amount you can qualify for. Just don’t use more than 10% of the limit. The most essential part of this strategy is your discipline after you’re approved. If you can keep yourself from going out and buying things with your new line of credit, you can really protect your credit scores.

This way, even if your HELOC is misinterpreted as a credit card, your credit scores can’t be hurt…in fact, it could even help them.

So, a HELOC can be a good thing if your balance is extremely low or nonexistent.

This article written by guest blogger, Stephen at Life After Bankruptcy

Erik Folgate
Erik and his wife, Lindzee, live in Orlando, Florida with a baby boy on the way. Erik works as an account manager for a marketing company, and considers counseling friends, family and the readers of Money Crashers his personal ministry to others. Erik became passionate about personal finance and helping others make wise financial decisions after racking up over $20k in credit card and student loan debt within the first two years of college.

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