1SD Newsletter: July 2004
You Need to Know...
FICO Facts
TechWorks
PMC Conference - Future of AVMs


HELOC’S That Can Hurt You

impact on a FICO score -- especially if the borrower draws down the line-of-credit to where the credit ratio exceeds 30%. It could be quite a shock when it comes time to refinance to a new first loan. Here’s what you need to know.

A few weeks ago a major lender invited San Diego loan originators to attend a combo sales meeting and FICO training session. The hook was a FICO scoring expert, and it worked. In all about 800 LO’s showed up in hopes the mysteries of FICO would be revealed.

Most of the topics were straightforward and familiar. Then the subject of Equity Loans came up. The crowd was told to watch out for Equity Loans because some of them could lower a client’s score by being reported as Revolving Credit.

It’s well know that in FICO’s Hierarchy of Credit, Installment Credit (especially Mortgage credit) is superior to any kind of Revolving credit. That is, Revolving Credit will almost always give you more score deductions than Installment Credit.

The implication was clear: when a good sized equity loan gets reported as revolving credit it can have a major impact on a FICO score -- especially if the borrower draws down the line-of-credit to where the credit ratio exceeds 30%. That could be quite a shock when it comes time to refinance to a new first loan.
Unfortunately, we were never told what type of equity loan to watch out for. A week of so later a client who had attended the presentation asked us about this dangling mystery, and we promised a response.
Indeed, there are two kinds of equity loans: Home Equity Loans, (a.k.a., Second Loans) and Home Equity Lines of Credit. Both are backed by the equity in a property, and both are recorded with the title. But the Home Equity Loan has a fixed payment schedule, while the HELOC’s payment schedule is defined by the amount of credit drawn.

Most lenders agree that HELOC’s are revolving credit. In fact many lenders tie the LOC to a credit card – all the easier to access the funds!

This no special reporting indicator for HELOC’s, so they can be lumped in with credit cards. FICO knows this and tries to identify revolving trades that are actually HELOC's by excluding from revolving calculations any revolving trade great than a certain dollar amount. That number is somewhere between $35,000 and $50,000.

What this means is that if the HELOC is fairly high, then the HELOC will NOT be considered revolving credit in the FICO score calculations. But a $20,000 HELOC that has $18,000 of credit extended can be a major derogatory.

So, when you are designing a loan package and you expect to refinance in the near term, be careful of HELOC’s.