What’s a Home Equity Line of Credit (HELOC)?

A HELOC can turn the equity you’ve built in your home into a flexible source of funds for ongoing home renovations, debt consolidation, business expenses, or major purchases. But borrowing against your house isn’t a decision to take lightly.

Before applying, it’s important to know how HELOCs work, who can qualify, how much you can borrow, how monthly payments can change, and whether a HELOC is the best option for your goals.

What is a HELOC?

A home equity line of credit (HELOC) is a revolving credit line that lets you borrow money as needed over time, using your home as collateral to secure the loan. The amount you can borrow (your credit limit) is based on your home equity. Unlike a home equity loan (which issues a lump sum upfront), a revolving credit line like a HELOC allows you to make multiple withdrawals over a set number of years.

HELOCs have two separate stages:

• Draw period: You can withdraw money as needed, generally up to your borrowing limit. You're typically required to make some type of payments toward what you borrow. Draw periods often last 10 years, but they can be shorter or longer depending on the lender’s terms.
• Repayment period: After the draw period ends, the dedicated repayment period begins. You can’t make any more withdrawals at this time. Repayment periods often last 10 to 20 years but can also vary by lender.

"One way to think about a HELOC is as a more responsible credit card," says Karri Noble, senior vice president of direct lending operations at loanDepot. "It provides a revolving line of credit that allows you to borrow what you need, repay it, and borrow again during the draw period. Because it’s secured by your home’s equity, a HELOC typically offers a much lower interest rate than most credit cards." But it also carries greater risk — you could potentially lose your home if you default on the loan. 

HELOC features

HELOCs have multiple moving parts, including the interest rate, ongoing fees, how you access money, how you repay it, and when you can deduct HELOC interest on your taxes. 

Interest rates

HELOC rates are typically variable, meaning they can increase or decrease over time.

Though less common, some lenders offer fixed-rate HELOCs. In some cases, the rate is locked for the entirety of the loan; in other cases, you may lock in a separate fixed rate for specific withdrawals.

Fees

HELOCs usually come with initial fees, such as an application fee, appraisal fee, and an origination fee. These are often referred to as HELOC closing costs.

Beyond these upfront costs, many HELOCs have annual fees. Some lenders may even charge inactivity fees if you don’t make frequent enough withdrawals during the draw period; others may charge you a fee each time you make a withdrawal, or if you withdraw less than the required minimum amount. Lenders might also allow you to lock in a fixed rate.

Always review a lender’s fee schedule thoroughly before committing to a HELOC so you have a fuller picture (beyond the interest rate) of how much it costs to borrow.

Borrowing

Some HELOC lenders require you to borrow an initial amount when you first start your HELOC or may require minimum withdrawal amounts. Often, lenders issue special checks or a HELOC credit card so you can conveniently withdraw money as needed during the draw period.

Repayment

While there’s a dedicated repayment period for your HELOC, you’ll likely have to make payments during the draw period as well. Some lenders may require minimum monthly payments that go toward both the principal (what you’ve borrowed) and interest. Other lenders might require interest-only payments during the draw period, but that will leave you with more to repay when the draw period ends. You also may choose to make payments toward the principal at any time.

If you borrow up to your max borrowing limit during the draw period, you’ll have to pay down some of the balance before you can make additional withdrawals.

Taxation

If you use a HELOC to substantially improve your home, such as upgrading your flooring, remodeling your kitchen, or repairing your roof, the interest you pay could be tax-deductible up to certain dollar amounts. You’ll have to itemize to claim the deduction; talk to a tax professional if unsure whether your expenses qualify.

What are HELOCs used for?

You can use a HELOC for almost anything. Lenders don’t typically put restrictions on how you use the money, but HELOCs make the most sense for home renovations or repairs, particularly ongoing projects. The ability to borrow money as needed during the draw period can help you deal with unexpected cost overruns, which are common with home improvement. Plus, you can often deduct HELOC interest, but only when the funds are used to substantially improve your home (standard upkeep costs may not qualify).

Andrew Gardner, founder of LEAP Properties, warns that something many potential borrowers overlook is "whether the project they’re funding actually adds value. Borrowing against your house to replace an aging roof or fix a foundation is one thing. Borrowing against it for a vacation or a depreciating purchase is a very different decision."

You could use HELOC funds to pay off credit cards or consolidate debt, but you may not want to. With a HELOC, you risk foreclosure if you can’t repay the loan. With a credit card, for example, you generally don’t. 

How much can you borrow with a HELOC?

The amount you can borrow with a HELOC depends on how much equity you have in your home and the lender’s maximum combined loan-to-value ratio (CLTV) limit, often 80% to 85%. That means that the combined balance of your mortgage, HELOC, and any other loans secured by your home can’t exceed 80% to 85% of your home’s total value.

For example, assume your home is worth $500,000 and your lender allows a max 85% CLTV. In this scenario, your max borrowing amount is $425,000 (85% of $500K). But remember, that’s the max debt allowed across the HELOC and your primary mortgage. In this scenario, assume you still owe $300,000. The lender subtracts this amount from $425,000, leaving you with a max HELOC amount of $125,000.

What are the requirements to get a HELOC?

Just because you own a home doesn’t necessarily mean you’re eligible for a home equity line of credit. To get a HELOC, you typically need:

• Adequate credit score: HELOC lenders typically approve borrowers with fair or better credit only, usually with a credit score in the mid-600s or higher. Some lenders may approve you with a lower credit score, but a lower credit score often means paying a higher interest rate.
• Adequate equity: Many lenders require you to have at least 15% to 20% equity in your home. However, some have higher limits — like Navy Federal, which lets you borrow up to 95% of your home’s equity if you qualify. Keep in mind that your total debt — the primary mortgage and the HELOC debt — can be no higher than the lender’s maximum CLTV.
• Adequate debt-to-income ratio: Lenders review your monthly debt obligations and compare them against how much money you make each month. This reflects your debt-to-income ratio (DTI). Lenders typically require a DTI no higher than 43% to 50% for a HELOC.

How do HELOC payments work?

Although HELOCs have two stages — the draw period and the repayment period — the names can be a little misleading. You typically have to start making payments as soon as you borrow money during the draw period. Lenders may require principal and interest payments during the draw period, or interest-only payments until the repayment period begins.

While interest-only payments can make your monthly payments more affordable initially, they come with a tradeoff: You aren’t actually reducing your principal balance. 

"One of the biggest HELOC drawbacks is that lower payments during the draw period can create a false sense of progress," says Noble. "If you're making interest-only payments, you’re not actually paying down the loan balance." When the repayment period begins, your payments can increase significantly.

And because interest rates are often variable, your rate can rise or fall over time, which could change your monthly payment amount (even during the draw period). These fluctuations can make it harder to budget.

Pros and cons of using a HELOC

HELOCs offer some serious advantages, but weigh them against the drawbacks before you apply.

Details on the pros

• Access to money as you need it: You can withdraw money as needed, rather than all at once. This is helpful for ongoing home renovations, when you might not be sure of total project costs because work is happening in phases. Accessing only the amounts you need can reduce interest costs as well.
• Lower rates than most unsecured loans: Because HELOCs are secured by your home, they typically carry less lender risk compared to an unsecured credit card or personal loan. Less risk for the lender can result in lower interest rates for you.
• Interest may be tax-deductible: If you use the HELOC funds to buy, build, or substantially improve your home, the interest may be tax-deductible. Consult with a tax professional before taking any deductions you’re not sure about.
• Flexible repayment: Unlike a home equity loan, which requires a fixed monthly payment immediately, a HELOC may start with low, interest-only payments for several years.
• Higher borrowing limits: Assuming you’ve built significant equity, you could qualify for a much higher borrowing limit with a HELOC compared to how much you can borrow with a personal loan.

Details on the cons

• Foreclosure risk: Much like a primary mortgage, your home serves as collateral on a HELOC. If you default on the loan, the lender can potentially foreclose on your home.
• Fees: HELOCs typically have closing costs and may have ongoing fees, which can include annual fees, inactivity fees, and withdrawal fees.
• Variable rates: Most HELOCs have variable rates, which makes it harder to gauge the full cost of a HELOC when you apply. Monthly payments can also be unpredictable.
• Eligibility requirements: HELOCs aren’t for everyone, and being a homeowner isn’t enough to qualify. You need enough equity, stable income, and a good credit score to get a HELOC.
• Could complicate selling your home: If the proceeds from the house sale aren’t enough to pay off both the mortgage and the HELOC, you’ll generally need the money in cash to pay off the HELOC when you close.
• You could lose access to funds: Depending on the loan agreement, the lender may be able to limit your ability to borrow under specific circumstances that increase their risk. Examples could include if your home loses a substantial amount of its value or if losing your job affects your ability to repay the loan. 

Is a HELOC right for you?

A HELOC can be a useful borrowing tool if you have significant home equity, a strong credit history, and a clear plan for how you’ll use the money and repay what you borrow. Because you’re putting your home up as collateral, HELOCs are best for expenses that are worth taking on debt for, like major home improvements that boost your home’s value.

If you can handle slightly unpredictable payments and put the money to good use, a HELOC could be right for you. But if putting up your home as collateral feels too risky, you might need to consider unsecured loan options with higher interest rates.