A HELOC, home equity line of credit, is a revolving credit line secured by your home. It works something like a credit card in structure: you get access to a maximum borrowing limit, draw what you need when you need it, repay it, and borrow again.
The key difference from a credit card is that your home is the collateral. That makes HELOCs lower-cost than unsecured credit, but higher-stakes, defaulting puts your home at risk.
How a HELOC Works
A HELOC has two phases.
Draw period: Typically 5 to 10 years. During this time you can borrow from the line, repay, and borrow again. Many HELOCs require interest-only payments during the draw period, which keeps the monthly payment low but means you’re not reducing the balance.
Repayment period: After the draw period ends, the line closes and the outstanding balance converts to a fixed repayment schedule, typically 10 to 20 years. You now pay both principal and interest, which can noticeably increase your monthly payment compared to what you paid during the draw period.
How Much Can You Borrow
Lenders typically allow a combined loan-to-value (CLTV) ratio of 80% to 90%. This means your existing mortgage plus the HELOC line cannot exceed 80–90% of the home’s appraised value.
Example: Home worth $400,000 × 85% max CLTV = $340,000. If your mortgage balance is $250,000, the maximum HELOC line would be $90,000.
Higher credit scores and lower existing debt generally help you get approved for a larger line.
HELOC Rates
HELOCs typically have variable interest rates tied to the prime rate, which moves with the federal funds rate. When rates rise, your HELOC rate rises with them, and so does your payment.
Some lenders offer the option to convert a portion of your HELOC balance to a fixed rate. This can provide stability on a specific draw while keeping the rest of the line variable.
HELOC vs Home Equity Loan
These are often confused because both borrow against home equity. The key differences:
| HELOC | Home Equity Loan | |
|---|---|---|
| Structure | Revolving credit line | Lump-sum loan |
| Rate | Usually variable | Usually fixed |
| Draws | Borrow as needed | Receive all at once |
| Best for | Ongoing or uncertain costs | One-time expense |
| Payment during draw | Often interest-only | Full principal + interest from day one |
If you know exactly how much you need and want predictable payments, a home equity loan may be more appropriate. If you need flexibility, a renovation with uncertain costs, a business expense that may vary, a HELOC fits better.
What HELOCs Are Used For
Common uses:
- Home renovations: The most common use. Costs can be unpredictable, so the revolving structure suits the project timeline.
- Debt consolidation: Replacing higher-rate debt (credit cards) with a lower-rate secured line. Effective in principle, but it converts unsecured debt to debt backed by your home, risky if you can’t keep up payments.
- Education expenses: Spreading tuition payments over multiple semesters fits the draw-as-needed structure.
- Emergency buffer: Some homeowners open a HELOC and leave it unused as a backup, essentially a secured emergency fund.
The Risks
Variable rate exposure: When rates rise sharply, so does your payment. What seemed manageable at 6% becomes harder at 9%.
Your home is collateral: A HELOC is a mortgage. If you can’t repay, the lender can foreclose, this is a fundamentally different risk than defaulting on a credit card.
Overspending temptation: Easy access to a large line of credit can encourage borrowing for things that don’t add lasting value.
Payment shock at repayment: If you’ve only been paying interest, the shift to full principal-and-interest payments at the start of the repayment period can be a significant jump.
Housing market dependency: If home values fall, your available equity shrinks. Lenders can reduce or freeze a HELOC if they believe the collateral value no longer supports the line.
HELOC Costs
Typical fees to ask about:
- Appraisal fee: $300–$700 for a formal home appraisal
- Application and origination fees: Varies; some lenders waive these to compete for business
- Annual fee: Some HELOCs charge $50–$100 per year to keep the line open
- Inactivity fee: Charged if you don’t use the line for a period of time
- Early termination fee: Some lenders charge a fee if you close the HELOC within a few years of opening it
Many lenders advertise “no closing costs” HELOCs, read the fine print to confirm whether fees are waived or just rolled into the rate.
Tax Deductibility
Interest on a HELOC may be tax-deductible if the borrowed funds are used to buy, build, or substantially improve the home securing the debt. Using HELOC funds for other purposes, paying off credit cards, vacations, doesn’t qualify for the deduction. Consult a tax professional for your specific situation; IRS Publication 936 covers home mortgage interest rules.
Frequently Asked Questions
Q: Can I get a HELOC if I have a first mortgage?
Yes. A HELOC is a second lien on the property. Your first mortgage remains in place. The HELOC lender is in second position, meaning in a foreclosure the first mortgage lender is paid first.
Q: What credit score do I need?
Most lenders require a minimum score of 620, with better rates available at 700 and above. The better your credit, the better the rate.
Q: Can the lender reduce or freeze my HELOC?
Yes. Lenders can reduce your credit limit or freeze the line if your home’s value declines significantly, your creditworthiness changes, or the lender determines there’s been a material adverse change. This happened to many homeowners during the 2008 housing downturn.
Q: How is a HELOC different from a cash-out refinance?
A cash-out refinance replaces your existing mortgage with a new, larger mortgage. A HELOC adds a second line of credit on top of your existing mortgage. With a refi, you pay closing costs and restart your mortgage term. A HELOC typically has lower upfront costs but carries variable rate risk and adds another payment.