Buying a home is not like any other purchase you’ll make during your lifetime. For one thing, it lasts for years, decades, after you sign the mortgage. Your financial situation may change considerably over the years, causing a corresponding change in things like a credit rating.
Let’s look closer at the link between home equity loans and credit scores to understand some of the financial calculations homeowners make and how professional mortgage brokers facilitate flexibility.
What Is a Credit Score?
To understand how credit scores work, let’s make an illustrative everyday comparison that should help clarify things — a quarterback rating in professional football. Basically, in NFL football, fans and coaches can understand how good or bad a quarterback is by their “quarterback rating,” which objectively quantifies a quarterback’s quality by weighing all their stats evenly and plugging them into a formula.
In North America, adults get a “credit score,” an economic indicator of how risky it is for lending institutions to let them borrow money. Essentially, lending institutions want to know how likely someone is to pay their bills on time.
Whereas quarterbacks are assessed by stats like touchdowns, interceptions, and completed passes, a credit score factors in things like payment history, the amount of used versus total available credit, and more.
Unlike quarterback ratings, there are a few different types of “credit scores,” as various financial institutions have their own ways of measuring and assessing risk. For example, US credit bureau companies like Equifax may rate you differently than a particular bank or lender.
A credit score indicates risk and financial health, so lenders use it to determine your eligibility for loans and decide what terms you’ll receive.
Do New Loans Impact Your Credit Score?
While different credit score formulas weigh things differently, new loans you take out are a significant component of your financial health. Any snapshot of your ability to repay loans must take this into account.
In short, a new loan will definitely impact your credit score. But pretty much everything you do bears financially on your credit score, so it’s more important to think of how it does, rather than if.
What’s the Impact?
Any new credit you take out causes a creditor to inquire about your financial health, which usually results in a slight drop in your credit score, though this depends on your current health. For most people, their score will drop by five or so points.
The more lenders inquire about your financial health, the more likely it is to drop. However, if you’re shopping for one type of loan within a window of 2-4 weeks, multiple inquiries get bundled into one. So conducting one large sweeping search mitigates any reduction in credit scores.
Home Equity Loans Can Increase Your Credit Score
Lenders like some borrowing profiles more than others. The relevant question isn’t merely how much a person has borrowed but what type of lending arrangement they’ve secured. Credit reports featuring different types of loans and credit cards appeal to lenders because it shows that the borrower can manage multiple forms at once.
If your credit report mostly consists of credit cards, adding a home equity loan can boost your credit mix and actually increase your credit score. There are flexible borrowing options like a HELOC, which lets homeowners leverage the equity they’ve built up over the years to pay for major expenses like renovation, home repair, investment opportunities, or emergencies.
Financial institutions understand the difference between recklessly borrowing money to pay for personal extravagances and carefully taking advantage of years of mortgage payments, and they rank them accordingly.
It’s better to take a more holistic view of your financial health and do what makes the most sense for your specific financial situation and lifestyle goals. While the best mortgage brokers will state that your money is free to use as you please, they’ll also give important advice about the most prudent way to leverage home equity loans.
If you decide to spend the borrowed money on a luxury vacation or a new car, nobody can stop you. However, the failure to make repayments can result in stiff penalties, including the loss of your home.
Most experts advise reinvesting the borrowed money back into your home so the value of the asset you’re borrowing against increases. A poor use of a home equity loan results in having to pay borrowing fees on top of what you’re buying, which is usually expensive.
On the flip side, if you spend the home equity loans on things like a renovation, your home will rise in value, which helps to offset the borrowing costs.
Credit Score is Just One Factor
Homeownership is a long-term process, so the real question isn’t whether your credit score will temporarily go up or down. Even if it were to dip when you take out a home equity loan, and there’s no guarantee it would, tapping into your home equity can be more than worth the brief drop.
Economic metrics are tools to help you balance your finances and understand your spending. They aren’t goals to pursue in and of themselves. Major milestone purchases may involve taking on a reasonable amount of debt.
Burke Financial is proud to work with homeowners of all levels of income, credit, and debt, even if they’ve been denied a loan by the bank. We offer a range of home equity loan solutions to fit every budget and lifestyle, so never feel like you’re out of options.
As interest rates rise and borrowing becomes more expensive, you may need to tap into the equity you’ve already earned through years of making monthly mortgage payments. Just like a credit score weighs various aspects of a person’s finances, a credit score is only one piece of a larger puzzle which must be contemplated together.
Everybody has unique financial circumstances and life goals, so there’s no one path forward that everyone should follow. To get the best home equity loan for you and understand how your credit score can impact your home financing, speak to the professionals at Burke Financial today.
