Despite record amounts of home equity, fewer homeowners are tapping into this source of wealth. While a number of factors contribute to this fact – including tightening lending standards – could concerns about a home equity loan’s effect on credit score play a role?
To determine the impact a home equity loan could have on a borrower’s credit profile, LendingTree analyzed data from 2,500 consumers to see how their credit scores changed in the months after they took out a loan.
The report found that borrowers saw their credit scores decline by an average of just 13 points. According to LendingTree, because the average credit score of borrowers was 735 to start, such a decline would have a negligible impact on access to credit and would only marginally increase the cost of credit.
LendingTree also noted that it took about 60 days after closing or longer for the loan to show up on a borrower’s credit report.
The decline in credit score took an average 158 days to reach its lowest point, and then about 163 days to recover completely, meaning that the complete cycle to return to the original credit score was 321 days, or less than 11 months, the survey found.
Why is a borrower’s credit score affected at all?
LendingTree says scoring agencies take into account the total amount of money a consumer owes, and the presence of a large line of credit drags down that score, although with less weight than a large increase in outstanding debt.
But, over time, the impact is lessened, LendingTree says.
“Making on-time payments helps a borrower improve their credit score as they demonstrate they are managing their new home equity loan account well. If it is a home equity line of credit and the borrower does not use the full credit line, their credit utilization ratio falls – which also boosts their credit score,” LendingTree notes. “Having a home equity loan also increases the diversity of accounts in the credit file, which boosts the score as well. Eventually, the score returns to its pre-loan level, and in most cases surpasses it.”
Here is a chart ranking cities by average decline in credit score as a result of a home equity loan: