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One of the benefits of owning your own home is that you build equity you can tap into for cash. A home equity line of credit (HELOC) is one way to borrow against your home’s equity.

A HELOC is a revolving line of credit, meaning you can borrow up to a certain limit, pay off the debt, and then borrow the funds again. Because your home serves as collateral for the credit line, a HELOC is actually a mortgage loan — also known as a second mortgage.

Most HELOCs have variable interest rates that change periodically. However, there are exceptions. Here’s everything you need to know about HELOC interest rates.

How often do HELOC interest rates change?

The interest rate a lender charges on a HELOC is based on an underlying index rate, which is a benchmark rate that reflects the general economy. Lenders add a markup, called a margin, to the index rate.

For example: If the prime rate is 7.75% and the lender charges a 1% margin, the HELOC interest rate would be 8.5%.

That 8.5% would be the initial rate when you take out the HELOC, but it will change as the prime rate does. Your lender will disclose how often your HELOC rate will adjust. It could be as often as once per month.

Can I get a fixed-rate HELOC?

HELOCs are typically variable-rate loans. But you won’t necessarily have to pay a variable rate for the entire term of the loan. Some lenders offer HELOCs with an initial fixed rate for a limited period of time. Additionally, many lenders allow borrowers to lock some or all of their outstanding principal balance into a fixed rate.

Think of the locked amount as a loan within a loan. Unless you move it back into the variable rate, you’ll begin making principal and interest payments right away, just like you would with a standard home equity loan.

Keep in mind: You’ll have to pay a fee to transfer your HELOC principal balance to a fixed rate, and you can only make these transfers during the draw period.

Pros and cons of a home equity line of credit

A HELOC can be a great choice for some homeowners, but there are downsides to consider.

Pros

  • A long draw period gives you years of financing with a single loan.
  • Because the line of credit is secured by your home, interest rates for a HELOC can be much lower than for a credit card.
  • You can borrow from your credit line as often as you need during the draw period.
  • Interest-only payments during the draw period make the earlier years of the loan more affordable.
  • You can lock some or all of your principal balance into a fixed rate if interest rates are on the rise.
  • HELOCs typically have a cap on how much the variable rate can increase each year and over the life of the loan.

Cons

  • Your home serves as the collateral for the loan. If you default on your payments, the lender can foreclose.
  • A HELOC can be too easy a source of funds for undisciplined borrowers who might be tempted to use the line of credit — and deplete their home equity — for non-essential expenses.
  • A variable rate means your payments change frequently, which makes budgeting difficult.
  • The loan is due in full if you sell your home. Loan fees and closing costs could leave you underwater if the value of your home declines between the time you take out the loan and the time you sell.

How to qualify for a HELOC

The eligibility requirements for a HELOC are similar to those for a home equity loan. Here’s what most lenders look for:

  • Sufficient equity: You’ll need to have at least 15% to 20% equity in your home to get a HELOC.
  • Minimum credit score: You’ll need a credit score of at least 620 to qualify for most HELOCs, although many lenders require a higher score.
  • Credit history: Lenders will perform a hard credit check to assess your ability to responsibly manage debt.
  • Debt-to-income (DTI) ratio: In addition to checking your credit score and history, lenders want to make sure that you’ll be able to afford your monthly loan payments. For most home loans, lenders like to see a DTI ratio no higher than 43%.

How to get a HELOC

Applying for a HELOC doesn’t have to be intimidating. You’ll follow six simple steps.

  1. Decide how much you need to borrow. Knowing how much equity you have will give you an idea of how much you’ll be able to borrow for a HELOC. Lenders will typically allow you to borrow 80% to 85% of your equity.You won’t know for sure how much equity you have until the lender orders an appraisal of your home, but you can get a rough estimate by researching prices of recent closed sales of local homes similar to yours using home comparison sites like Zillow and Redfin. Then subtract your current loan balance from your value estimate.
  2. Compare lenders. If you’re thinking of getting a home loan, it’s important to consider multiple lenders and loan options to find the best loan for your unique financial situation.When comparing lenders, consider interest rates — promotional and regular rates — as well as draw periods, repayment terms, fees, and if you’ll have the option to lock in a fixed rate.
  3. Gather financial documents. You’ll need to provide paperwork such as pay stubs, recent tax returns, bank statements, and statements showing outstanding debt balances. You may also want to include your most recent mortgage statement, property tax bill, and homeowners insurance policy as well.
  4. Submit your loan application. Once you’ve decided on a lender, you’ll complete an application and provide any additional documents the lender requests.
  5. Read the fine print. Before you sign a loan agreement, make sure to read the disclosures carefully. The disclosures contain information about your annual percentage rate, repayment terms, and requirements that affect how much and how often you can draw from your balance.
  6. Close on the loan. If you accept the terms of your loan agreement, you’ll close on your loan. Because HELOCs are home loans, they come with closing costs similar to a standard mortgage. Closing costs range from 2% to 5% of your loan amount and cover expenses such as appraisal fees, attorney fees, and title search fees.

Alternatives to a home equity line of credit

A HELOC is a good choice for some borrowers, but it’s not the only option. Here are some more to consider:

Home equity loan

A home equity loan is a one-time lump sum draw against your home equity. Unlike a HELOC, a home equity loan typically has a fixed rate and repayment terms of anywhere from five to 30 years. You repay the loan in monthly payments that remain the same for the entire loan term.

You might be better off with a home equity loan if you have a one-time need for cash. To borrow more than your initial loan amount, you’ll have to take out a new loan — assuming you still meet equity and DTI requirements.

Personal loan

A personal loan can be secured by collateral, or it can be unsecured, meaning there’s no collateral to ensure the lender gets paid if you default on your loan.

Personal loans are typically fixed-rate installment loans, meaning you receive the funds in a lump sum and begin making payments immediately. Because they tend to have fixed rates, the amount you owe each month won’t change over time.

Because most personal loans are unsecured, they tend to come with higher interest rates than secured loans. But a personal loan might be the best choice if you need a small loan amount and you need the funds quickly, as many lenders are able to disburse the funds within a business day or two of approval.

Cash-out refinance

With a cash-out refinance, you’ll take out a new loan that’s larger than your current mortgage balance. The new loan pays off your existing mortgage loan and you receive the remaining funds as cash.

You might use a cash-out refinance for the same kinds of expenses you’d finance with a home equity loan or HELOC. However, a cash-out refinance also lets you change the rate and term of your current mortgage. You can also switch from a variable rate to a fixed rate, or vice versa.

Credible doesn’t offer HELOCs, but you can compare cash-out refinancing offers directly on our platform — it only takes a few minutes to see your prequalified rates.

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Frequently asked questions

What is a HELOC?

A home equity line of credit, or HELOC, is a revolving line of credit, similar to a credit card. Essentially, you borrow against the equity in your home and the credit line is secured with your home as collateral. Lenders will typically give you a credit limit of up to 80% of your home equity. Equity is the difference between the appraised value of your home and how much you owe on your mortgage.

For example: If your home is worth $300,000 and you have a $200,000 mortgage balance, you have $100,000 in equity. For a HELOC, your borrowing limit could be as high as $80,000.

How does a HELOC work?

You can draw funds up to your borrowing limit over the course of a specified amount of time, such as 10 years, known as the “draw period.” During the draw period, you’ll make interest-only payments on the amount you’ve borrowed. After the draw period ends, you typically have 10 to 20 years to repay the loan principal along with accrued interest.

How are HELOCs different from home equity loans?

HELOCs are structured differently than standard home equity loans, which allow you to borrow a lump sum of cash and repay it over a fixed term. Another difference is in the type of interest rate charged. Whereas most standard home-equity loans have fixed rates that stay the same for the whole loan term, HELOCs usually have variable rates that fluctuate periodically.

About the author
Daria Uhlig
Daria Uhlig

Daria Uhlig is a contributor to Credible who covers mortgage and real estate. Her work has appeared in publications like The Motley Fool, USA Today, MSN Money, CNBC, and Yahoo! Finance.

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