HELOCs & Credit Scores

Lots of people are now choosing HELOCs for their next mortgage.  HELOCs offer features like:

• Fully open terms
• Interest offsetting (where positive savings or chequing balances reduce your debt and interest)
• Readvancability (i.e.  the ability to re-borrow after you make principal payments)
• Multiple segregated sub-accounts (to separate different types of borrowing)
• Interest-only payments

What many don’t realize is that choosing a HELOC instead of a mortgage can have a potentially adverse effect on their credit score.  That’s because HELOCs are often reported to credit bureaus while mortgages are generally not. (In cases where mortgages are reported, sources at Equifax, the nation’s largest credit bureau, say they don’t harm your score).

We recently came across a case where a person’s credit score dropped 80 points after putting their $300,000 mortgage in a HELOC.

Causation is hard to quantify because Equifax doesn’t disclose it’s scoring algorithms, but here are the facts of this particular case:

• The individual’s score before the HELOC was in the low 700’s. Following the HELOC being reported to the credit bureau, the score fell below 630.
• There were no other major differences on this individual’s two credit reports (i.e. the report before the HELOC and after)
• After the HELOC closed, an explanatory note appeared on the person’s credit report stating that his balances were too high in relation to his credit limits.
• The lender reported the HELOC balance as being 99% of the HELOC limit. (Which is common when the mortgage amount and HELOC limit are similar)

Given that Equifax bases 30% of its Beacon scores on credit utilization and 15% on account age, a brand new $300,000 HELOC, at 99% of it’s limit, is a big potential negative.

Now, an 80 point drop is not catastrophic to some people, but to many others it can be.  80 points is over 10% of the average Canadian’s score.  A drop like that can cause you to no longer qualify for financing on other properties, for financing on consumer loans, for credit cards, and even for getting a job (some employers check credit before hiring).

At the very least, it’s something to keep in mind when comparing lines of credit.  There are a handful of lenders who do not report HELOCs to the bureaus.  If you’re concerned about your score, you’d do well to consult a mortgage professional and consider those options.