HELOC is short for Home Equity Line of Credit

HELOC stands for Home Equity Line of Credit. It is a loan product that lets you borrow money using the equity you have built up in your home as collateral. Unlike a traditional second mortgage, a HELOC works more like a credit card — you get access to a pool of money and draw from it as you need it, paying interest only on what you actually use.

The amount you can borrow depends on how much equity you have. If your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in equity. Most lenders will let you borrow 80 to 90 percent of that equity, though the exact amount varies by lender and your credit history.

Key Takeaways

  • HELOC stands for Home Equity Line of Credit and lets you borrow against the value you have built up in your home.
  • You only pay interest on the money you actually borrow, not on the full credit line available to you.
  • HELOCs have two phases: a draw period when you can borrow, and a repayment period when you must pay back what you borrowed.
  • Your home is used as collateral, which means the lender can foreclose if you stop making payments.
  • Interest rates on HELOCs are usually variable, meaning they can go up or down over time based on market conditions.

How a HELOC differs from a home equity loan

A home equity loan and a HELOC both use your home as collateral, but they work differently. With a home equity loan, the lender gives you a lump sum of money all at once, and you repay it in fixed monthly payments over a set number of years. With a HELOC, you get a credit line you can draw from whenever you want during the draw period, usually 5 to 10 years.

The payment structure is also different. On a home equity loan, your payment amount stays the same every month. On a HELOC, your payment changes based on how much you have borrowed and what the current interest rate is. This makes a HELOC more flexible if you do not know exactly how much money you will need or when you will need it.

The draw period and repayment period

A HELOC has two distinct phases. During the draw period, usually 5 to 10 years, you can borrow money from your credit line as often as you want. You make minimum payments during this time, which typically cover only the interest on what you have borrowed. Some lenders let you pay interest-only; others require you to pay some principal as well.

After the draw period ends, the HELOC enters the repayment period, which usually lasts 10 to 20 years. During repayment, you can no longer borrow new money. Instead, you must pay back everything you borrowed plus interest in monthly payments. These payments are often much larger than what you paid during the draw period, because now you are paying down the principal.

This structure matters for your budget. If you take out a HELOC at age 55, the draw period might end when you are 65, right around retirement. You would then face large repayment payments on a fixed income. Understanding when your draw period ends is important before you sign.

Interest rates and how they change

Most HELOCs have variable interest rates, meaning the rate changes over time. The rate is usually tied to a benchmark like the prime rate, which moves up and down based on what the Federal Reserve does. When the prime rate goes up, your HELOC rate goes up. When it goes down, your rate goes down.

Some lenders offer a fixed-rate option for part or all of your HELOC, but this is less common and may come with a higher starting rate. If you lock in a fixed rate, your payment stays the same for that portion of the loan, even if market rates change. Many borrowers use a mix — a fixed rate on part of what they borrowed and a variable rate on the rest.

The variable rate means your monthly payment can change. If rates rise significantly, your payment could increase hundreds of dollars per month. This is different from a fixed-rate mortgage, where your payment never changes.

What happens if you do not pay

Because your home is collateral for a HELOC, the consequences of not paying are serious. If you miss payments, the lender can foreclose on your home and force a sale to recover what you owe. This is the same risk you face with your primary mortgage.

Foreclosure does not happen immediately after one missed payment, but it can begin after 120 days of non-payment in most states. Before foreclosure starts, the lender will contact you about the missed payments. If you are having trouble making payments, contact your lender right away to discuss options like a payment plan or temporary forbearance.

Common reasons people use a HELOC

People use HELOCs for many different purposes. Some use them to pay for home repairs or renovations, since they can draw money as the work progresses. Others use them to consolidate high-interest debt like credit cards. Some use them as an emergency fund, keeping the line open but unused until they need it.

A HELOC can also be used to pay for education, medical expenses, or a business startup. Because the interest rate is usually lower than credit cards or personal loans, borrowing against your home can be cheaper than other options. However, this lower rate comes with the trade-off that your home is at risk if you cannot repay.

Questions to ask before opening a HELOC

Before you sign up for a HELOC, understand the terms. Ask your lender: How long is the draw period? How long is the repayment period? What is the current interest rate, and how is it calculated? Is there a cap on how high the rate can go? Are there fees to open the account, draw money, or close it early?

Also ask what happens at the end of the draw period. Some lenders automatically convert the HELOC to a fixed-rate loan. Others require you to refinance or pay off the balance. Knowing this in advance helps you plan your finances and avoid surprises.

Frequently Asked Questions

Can I use a HELOC to buy a second home?

Yes, you can use HELOC funds for almost any purpose, including buying a second home. However, the interest rate on a HELOC is usually higher than a traditional mortgage, so it may not be the cheapest way to borrow for a home purchase. Compare the total cost of a HELOC against a mortgage before deciding.

What if my home value drops and I have less equity?

If your home value falls, your lender may reduce your credit line or freeze it entirely. This happened to many borrowers during the 2008 housing crisis. You can still owe what you already borrowed, but you cannot borrow more. If you have not yet drawn on the line, you may lose access to it.

Can I pay off a HELOC early?

Yes, you can pay off a HELOC at any time without penalty in most cases. However, some lenders charge an early closure fee if you close the account within a certain number of years. Check your agreement for any fees before you sign.

Is the interest on a HELOC tax deductible?

Under current federal tax law, interest on a HELOC is deductible only if you use the borrowed money to buy, build, or improve your home. If you use HELOC funds for other purposes like paying off credit cards or medical bills, the interest is not deductible. Consult a tax professional about your specific situation.

What credit score do I need to open a HELOC?

Most lenders require a credit score of at least 620, though many prefer 700 or higher. The higher your score, the better the interest rate you will receive. Lenders also look at your income, debt-to-income ratio, and how much equity you have in your home.